The January Effect is a theory which says that stock prices take a dip every December and then receive a boost in January when investors buy back the same stocks they sold in the previous month. It’s a phenomenon driven by tax planning; investors sell off stocks at a loss before the end of each year in order to mitigate their upcoming capital gains taxes. After being out of the stock for thirty days, they can come back in January and buy the exact same stock anew while still getting their write-off.
Proponents of the January Effect point to S&P 500 returns in the month of January since 1950, which have gained, on average, 1.8% for the month compared to an average rise of 0.7% in other months. However, the January Effect remains hotly debated.
Efficient market theorists contend that calendar-based fluctuations are a sign of an inefficient market, and markets have clearly become more efficient since The January Effect was first observed in 1942 by investment banker Sidney B. Wachtel. There’s a school of thought among those theorists that the January Effect happens, but it happens back around the previous Thanksgiving.
I’d certainly fall into that camp. In my case, I did a lot of swaps back in April, especially with financials, selling one large bank stock for a write-off and replacing the asset allocation with a similar-but-different one. To be sure, 2020 has been an aberrational year, but generally speaking, I’d say that the “January” effect still happens but has in recent years become less tightly confined to the one month. This year’s extreme volatility just exacerbated the situation.
The hyper-growth of the mutual fund industry over the last fifty years has also contributed to the phenomenon getting moved up the calendar. The majority of the approximately 8,000 mutual funds currently in existence have an October 31 fiscal year end, so markets experience the results of their tax planning earlier now. I suppose that the stock market’s performance since the last day of October corroborates that-- this November has been the best month for stocks since 1987.
US initial jobless claims rose for the second week in a row, rising sharply to 778k for the week ending November 21. It seems likely that we’re going to experience another huge spike in coronavirus cases this month with severe lockdowns, more layoffs and no additional economic stimulus. Therefore, after this boomer of a November and our (well documented) overweight positioning in small-cap and large international stocks, we recommend that investors take an active approach to their risk management. While we continue to believe that the U.S. economy is a dweller on the threshold of a multi-year bull market, we feel there’s a strong likelihood of increased volatility this month.
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