Is the January Effect Real?

Spoiler alert: probably not.

There was a time, though, when the “January effect”—an increase in equity purchases in January and a subsequent rally in stocks—seemed valid to some, especially since it came on the heels of a stock price drop that often occurred in December.

In fact, there has been some historical evidence supporting the January effect for smaller cap stocks, though it has been less pronounced in recent decades than it was in the past. Why it might have happened is another matter. Some have argued that tax-loss selling, which typically happens in December, is offset by investors putting year-end bonuses and new investment strategies to work in January.

Maybe the markets have adjusted to the so-called January effect. Or perhaps ongoing contributions to tax-sheltered retirement plans have evened out the variations of seasonal flows. In any event, the hypothesis seems more and more flimsy over time.

With these thoughts in mind, I came across a brief column from Dimensional Fund Advisors that illustrates what happens to stocks after January. Dimensional wondered whether January serves as a useful proxy for stock behavior during the remainder of the year. Interestingly, they found that going back to 1926, a negative January return for the S&P 500 was followed by a positive 11-month return for the index about 60 percent of the time. And while the S&P 500 did gain in January over 60 percent of the time, the results aren’t so overwhelming to proclaim January a surefire winning month.

What does the rest of Dimensional’s data tell us? Certainly, there’s not enough evidence to support making any bets based on January. For the most part, it’s like any other month, particularly when we broaden the discussion to include other asset classes such as small caps, foreign stocks, and emerging markets.

Bottom line:  We suggest that you not try to beat the market based on somebody’s hunch—whether it’s the January effect or some other thinly-based theory.