The January effect is a term to describe a phenomenon in the financial markets in which securities prices increase during the month of January. The concept was first introduced in 1942 through a paper by Sidney Wachtel. As the January effect has become a more well-publicized phenomenon, it has led to the "Santa Claus rally." The idea is that investors anticipate stocks moving up in January and try to get out in front by buying around Christmas.
What causes the January effect?
Several scholarly papers have been written since 1942 suggesting various drivers for the January effect, but there is no definitive evidence of an exact or single cause. Two of the most popular sources on the subject are "The Incredible January Effect: the stock market's unsolved mystery" by Robert Haugen and Josef Lakonishok (published in 1987), and a 2005 paper from a team at William & Mary. A few of the driving factors often mentioned as causes of the January effect are:
- Holiday Psychology: Behavorial finance, as a front in its war on the efficient market hypothesis, attributes the January effect to a rosier, more positive mindset for investors following the festive holiday season. After the Christmas season, individuals are more pre-disposed to invest.
- Tax Motivation: Investors might also be motivated to sell losing stocks at the end of the year to offset some capital gains for year-end tax reporting purposes, and then, after the expiration of the 30-day wash rule, buy those securities back.
- Shoppers Raising Cash: Investors who need liquidity for holiday shopping might dump securities to raise cash, after which bargain hunters come in during January to scoop up those discounted stocks.
- Small Cap Year-End Research Reports: Small cap stocks often release year-end research reports, and some believe these reports make small cap stocks more attractive investments near year-end.
*DISCLOSURE: No relevant position