The January effect under the magnifying glass

The January effect under the magnifying glass

January, more than any other month, is said to be the month when stock markets tend to rise the most. This phenomenon was first observed in 1942 by an investment banker who was then studying performance back to 1925. Over the years, researchers have confirmed this theory for US stocks as well as other classes. of assets and in international markets. Although there is no guarantee that this theory will always hold true, it is surprising to observe this type of recurring phenomenon in markets that are considered to be generally efficient.

The January effect: myth or reality?

Several reasons have been put forward to explain this effect. The January effect would, for example, be due to the search to optimize performance after tax. In the United States, it is not uncommon for an investor to sell their shares in the red in December in order to use these deadweight losses to offset or reduce capital gains tax. If he remains convinced of the long-term prospects of these stocks, he will probably buy them back in January, which will drive up demand for them. Although confirmed by some researchers, this theory does not fully explain the January effect. Indeed, this anomaly has also been observed in countries where the fiscal year does not end in December, or countries which do not tax capital gains.

Another possible explanation is that in January, employees receive their bonus for the past year and decide to invest it in the stock market. Retail investors, however, are unlikely to exert such influence on the market.

The dressing of the balance sheet (window dressing) would be a third plausible explanation. As year-end approaches, professional asset managers would be more inclined to rebalance their portfolios and shed speculative or losing stocks that may not be to clients’ liking in annual reporting. This phenomenon exerts downward pressure on prices at the end of December, before some form of rebound occurs in January when the pressure to sell eases.

Excessive optimism at the start of the year

Followers of behavioral finance also have their explanation. According to them, this effect is due to psychology. If we accept that we do not coldly and rigorously exploit data to the maximum, contrary to what the hypothesis of efficient financial markets suggests, and that we are human beings whose behavior is dictated by our moods and our emotions, the January effect could only be the manifestation on the markets of the optimism that accompanies a new year. It is indeed possible that investors will start the year with renewed determination and will, armed with new resolutions and new objectives for their operations.

We should also mention this last oddity: the January barometer. According to various studies, the month of January is, to some extent, predictive of market performance for the year. A weak January does not bode well for equities over the course of the year, and vice versa. This has been verified in 2022 and so far one could say that things are looking good for 2023.

While it is interesting to note these small market curiosities, we would like to remind you that they are not always true, especially in more developed markets, which are considered more efficient. This is why we come back to the advice we always provide to our clients: it is often futile to try to anticipate the evolution of the market. The best strategy is often to invest with a long-term investment horizon, avoiding costly round trips, both in terms of costs and performance.