The January Effect
It's true... throughout history, small stocks HAD obliterated
large stocks in January.
There is no comparison. From 1925 to 1993, small stocks beat
large stocks in January in 69 of the 81 years.
Even more amazing, the return difference has been about FIVE
percentage points... (roughly, big stocks had returned 2% in
January, and small stocks returned an astounding 7%).
On the surface, the January Effect appears like a promise of
"free money" during that month - just buy on the last trading
day in December and sell on the last day in January, and collect
a 7% return. Because of this, the entire financial world alerts
you to this January Effect on small stocks... your broker, your
magazines, CNBC, you name it. And therein lies the problem...
Today we'll take a brief look at why small stocks may have
soared in the past in January. And then I'll explain why I think
the January Effect is now just another Wall Street investment
scam - one that the financial world uses to get you to buy
stocks, but in reality the fabled January Effect actually won't
ever be a reliable strategy again.
The January Effect and Why Stocks Soar during this Month
Why do small stocks rise by 6%-plus in January? Is there a
logical reason for the January effect? It sure doesn't seem to
fit into the widely accepted "random walk" theory about stocks,
where stock prices move like a blind drunk in a field, and
therefore no month should be better than any other.
The reason for the January Effect is debated among academics.
The most common explanation is for tax reasons... Individual
investors sell their small stocks that have declined in December
to offset capitalgains taxes, and selling knocks down the prices.
There is some evidence for this, as there isn't proof of a
January effect before 1913, when taxes were introduced. And in
Australia, where the tax year actually ends in June, stocks show
a "July Effect."
New money into the market is also believed to have played a
part. The data shows there is an increase in public "buy" orders
in the new year versus sell orders. Whatever the actual reason,
there is no doubt that there at least WAS a January
Effect...until now.
Why the January Effect Is Now Dead
Psst... let me let you in on a secret that Wall Street doesn't
seem to know. The January Effect is now dead--the simple reason
being that once everyone on Wall Street knows something works,
it won't work anymore.
The January Effect was first discovered in the 1980s by Don
Keim. Never heard of him? Neither had Wall Street. But by the
early 1990s, everyone knew about Don Keim's discovery of the
January Effect. And once everyone knew it, it no longer worked,
as this table shows...
The January Effect Since 1994: Completely Worthless
1994 Small stocks lost to large stocks 1995 Small stocks lost to
large stocks 1996 Small stocks lost to large stocks 1997 Small
stocks lost to large stocks 1998 Small stocks lost to large
stocks 1999 Small stocks lost to large stocks 2000 Small stocks
lost money 2001 Small stocks BEAT large stocks AND made money!
2002 Small stocks lost money 2003 Small stocks lost money 2004
Small stocks BEAT large stocks AND made money!
(*I used the Russell 2000 Index for small stocks, and the Dow
for large stocks.)
Since 1994 the median return on small stocks in January has been
-0.2%. Said another way, since 1994, the January Effect has been
a money-losing strategy.
The returns on small stocks in January have been so bad since
1994 that I would suggest getting rid of any broker or
publication that is pitching you on buying stocks right now to
take advantage of this supposed January effect that doesn't
exist anymore...
In short, the January Effect is an interesting historical
anomaly--one that hasn't been profitable for many years, and in
my opinion will never be profitable again.
Good Investing, Steve