The myth
“The January Effect” is the belief that stock prices rise at the start of the year due to different factors. This theory says investors tend to buy more stocks in January because of renewed optimism, bonuses, taxes, or portfolio adjustments.
A lot of times, it is also seen as an extension of December’s “Santa Claus Rally”. If these seasonal patterns are indeed true, then it could mean that people may profit from them just by correctly timing their buying and selling activities.
The reality
The supposed January trend is said to be noted first by investment banker Sidney Wachtel in 1942. He studied US stock market performance starting 1925 and found that returns appeared to be higher in January than other months.
This effect has been attributed by many to different potential causes:
- Year-end bonuses
A lot of people get their bonuses at the end of each year. They might have more money to invest in stocks at the start of the new year.
- Investor psychology
The new year often brings renewed hopes and a newfound drive to reach for goals. Around this time, people may start working on their resolutions, including financial ones.
- Tax loss harvesting
Toward the end of the year, investors may sell underperforming stocks for tax purposes. This is because they’ll only need to pay taxes on the money they earned minus the money they lost, or their net profit.
This practice is known as tax loss harvesting and it offers a way to save on taxes. It may also add pressure to sell before the year ends then repurchase stocks in January, causing their prices to rise.
However, this concept does not apply in the Philippine stock market. Investors need to pay the stock transaction tax even if they’re selling at a loss via the Philippine Stock Exchange (PSE).
- Portfolio rebalancing
Another theory is that fund managers tend to clean up their portfolios around December in a move known as “window dressing.”
This means they might sell off the more volatile stocks on a fund's portfolio so they won’t appear on the annual report. Then, they’ll buy them back come January.
Some critics say that while the January Effect might have been observed in the past, its impact has likely weakened over time. They believe investors can quickly catch up and capitalize on trends, undermining their effect.
After all, if people knew for sure they’ll earn more if they sell shares in January, then they’ll start buying months ahead. The high demand may push the prices up during those earlier months, and not in January.
Others claim that even if the effect is real, it may only apply to certain stocks. You’ll still need to find out which stocks are likely to go up in value if you want to make money off the January Effect.
Verdict: It depends.
Market performance is driven by complex factors and may not be as simple as the January Effect theory makes it seem.
Predicting price movements is a challenge that even experts often fail at. This is because patterns can be disrupted by unexpected events.
You may find that a more reliable method is to study your options and read up on a company’s fundamentals instead of counting only on seasonal trends.
