The January Effect is one of the most widely discussed anomalies in the investment industry. Simply put, the January Effect is the perception that stock prices tend to increase in the month of January. If this is the case, why doesn’t everybody just back up the truck and put all their money in stocks every January? Does this anomaly have any merit, and where did it come from?
In 1942, investment banker Sidney Wachtel was studying seasonal movements in the market (we know, everybody’s favorite pastime) when he stumbled upon an anomaly. Going back to the 1920’s, Wachtel noted stocks seemed to perform better in the first month of the year, with most of the disparity occurring in the first half of the month.
While it was first observed nearly 80 years ago, it seems to get brought up every year in January. Some of the more popular theories as to how something like this could be possible include:
- Tax-loss harvesting, which includes selling losing stocks at the end of the year to offset capital gains, then buying back the stocks in January.
- Year-end bonuses being invested in January
This sounds almost too good to be true, so what’s the catch?
From 1928 through 2020, stocks (as measured by the S&P 500 Index) have been positive in 57 of 93 January’s – which is only 61.3% of the time. This means even if the average return in January is more positive than normal, you still would have lost money in over ⅓ of the years in this time period. Nobody knows exactly what is going to happen in any given month or year. The most recently completed January (2020) serves as a great example of this. Stocks were racing to record highs, but closed the month negative as early COVID fears began to set in.
Furthermore, research has shown that January isn’t even the best month for market returns. Since 1950, January is only the 5th best performing month (behind April, July, November, and December). Within this, every year is hit-or-miss as far as which months are the best and worst. There are good and bad Januaries, good and bad Februaries, etc. There is no way to tell which month is going to be the best in any given year until the year is finished – it depends more on what events are happening than what month of the year it is.
Using 2020 as an example again, March was the worst month as COVID shut down the global economy and April was the best month as investors were optimistic following stimulus and partial re-openings. Looking ahead through 2021, we could see two totally different months at the top and bottom of the list, or it could be March and April again… there is truly no way to know until the year is finished.
The past handful of years alone show how unpredictable and unreliable market anomalies like the January effect can be. Here are the returns as well as the rank against other months for January going back to 2015:
- 2020: -0.16% (8th)
- 2019: 7.87% (1st)
- 2018: 5.62% (1st)
- 2017: 1.79% (6th)
- 2016: -5.07% (12th)
- 2015: -3.10% (11th)
This is why it is important to focus on building a solid long-term investment strategy rather than chasing a loosely established market timing approach. While perceived market anomalies such as the January Effect can be fun to discuss and observe, it’s important to understand that they are anomalies and can’t be predicted consistently and knowingly over time.
January might have been a “special month” to invest in the past when markets were less efficient, but the case for using this as a strategy appears weak today.
Derek Prusa, CFA, CFP® and Ben Webster, CFP®
Co-Founders and Owners of Aspire Wealth
Beginning of the Year Financial Checklist
