Stocks in general and small stocks in particular have historically generated abnormally high returns during the month of January. According to Robert Haugen and
Philippe Jorion, "The January effect is, perhaps the best-known example of anomalous behavior in security markets throughout the world." 1 The January Effect initially persisted long after it's initial discovery, but some argue it has diminished over time. Theoretically an anomaly should disappear as traders attempt to take advantage of it in advance. Additionally, many have argued that some of the other anomalies occur primarily or entirely during the month of January (See
Interrelationships). The bottom line is that January has historically been the best month to be invested in stocks.
The effect is usually attributed to small stocks rebounding following year-end tax selling. Individual stocks depressed near year-end are more likely to be sold for tax-loss recognition while stocks that have run up are often held until after the new year. Some people have suggested at times that the January effect had moved into November and December as a result of mutual funds being required to report holdings at the end of October and from investors buying in anticipation of gains in January. Some studies of foreign countries have found that returns in January were greater than the average return for the whole year. Interestingly, the January effect had also been observed in many foreign countries including some (Great Britain and Australia) that don't use December 31 as the tax year-end. This implies that there is more to the January effect than just tax effects. See also
The Incredible Shrinking January Effect by William Bernstein (1999).
In The January Effect (Financial Analysts Journal September/October 2006) Mark Haug and Mark Hirschey summarized that "Analysis of broad samples of value-weighted and equal-weighted returns of U.S. equities documents that abnormally high rates of return on small-capitalization stocks continue to be observed during the month of January. This January effect in small-cap stock returns is remarkably consistent over time ... After a generation of intensive study, the January effect continues to present a serious challenge to the efficient market hypothesis." (Presentation).
January is also watched closely by many because strong market performance in January has historically indicated strong performance for the rest of the year. Forthcoming from Michael Cooper, John McConnell, and
Alexei Ovtchinnikov is What’s the Best Way to Trade Using the January Barometer? in The Journal of Investment Management, which follows their prior article
The Other January Effect in the Journal of Financial Economics (2006).
Stocks historically show higher returns around the turn of the month. Lakonishok and Smidt coined the phrase 2 and Frank Russell examined returns of the S&P 500 over a 65 year period finding that U.S. large-cap stocks consistently show higher returns at the turn of the month. Chris Hensel and William Ziemba 3 presented the theory that the effect results from cash flows at the end of the month (salaries, interest payments, etc.). They found returns for the turn of the month were significantly above average from 1928 through 1993 and "that the total return from the S&P 500 over this sixty-five-year period was received mostly during the turn of the month." The study implied that investors making regular purchases may benefit by scheduling to make those purchases prior to the turn of the month.
In Equity Returns at the Turn of the Month (which earned a Graham and Dodd Scroll Award)
John McConnell and
Wei Xu studied CRSP daily returns for the 80-year period of 1926-2005 (earlier version). Specifically, "turn-of-the-month is defined as beginning with the last trading day of the month and ending with the third trading day of the following month."
They found that the turn-of-the-month effect is pronounced over the recent two decades such that, when we combine our findings with those of Lakonishok and Smidt, the result is that over the 109-year interval of 1897-2005, on average, all of the positive return to equities occurred during the turn-of-the-month interval. They also concluded that it is not confined to small and low-price stocks, calendar year-ends or calendar quarter-ends, to the U.S, and is not due to a buying of shares at the turn-of-the-month since trading volume isn't higher and the net flows of funds to equity funds is not systematically higher. They concluded that the turn-of-the-month effect in equity returns poses a challenge to both “rational” and “behavioral” models of security pricing and it continues to be a puzzle in search of a solution.
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