THE JANUARY EFFECT
Country Routes - January, 1998
After the very volatile year we just went through, what will 1998 bring
us? A resumption of the historical bull market that began in 1991 or a
continual erosion of valuations? One indicator that may give us a clue
is what has come to be known as The January Effect . It is somewhat
baffling but consistent.
Let me briefly explain what it is. Small stocks outperform their larger
counterparts with uncanny consistency as the new year approaches,
defying market theory that suggests profitability should disappear as
the general market learns of an opportunity.
Reasons for the phenomenon, called the January Effect because of the
historical tendency to occur in early January, include tax-loss selling,
portfolio rebalancing, New Year optimism and even neglect. But, despite
more than 20 years of study none of the explanations explains the
Market experts still don't understand why the January Effect persists,
but they acknowledge it does, although, for futures purposes, it seems
to have moved into December. The January Effect is the tendency for
small stocks to outperform larger stocks as one year ends and the other
begins. Studies have documented that this has happened 80% to 90% of the
time over the 70 years beginning in 1926, and has prevailed whether the
market's overall direction is down or up. Despite widespread publicity,
the tendency continues to occur, and recent research suggests
fundamental reasons for why it may continue to do so. January tends to
be good to markets as a whole. Better- than-expected earnings reports
give stocks a lift at the beginning of the calendar year.
OTHER FACTORS TO CONSIDER
There is no guarantee past January Effect performance will repeat itself
this year or any other year and this article in no way is a
recommendation. Instead, it attempts to educate by using history as a
teacher. Please consult a professional before investing.
December 15 is closely watched by seasoned January Effect traders;
anyone seriously interested in investing should monitor the spreads
closely as that date approaches. Likewise, the last trading day of the
year, often was the peak equity date in the various futures and cash
strategies, particularly those involving the Russell 2000 . Market
analysts gave two reasons. First, portfolio managers, seeking to boost
quarterly or year-end reportable performance, might be engaging in
portfolio polishing plays on the NASDAQ by bidding up the price of less
liquid small stocks. Half the Russell 2000 stocks are traded on the
NASDAQ. Second, fund managers with quarterly proceeds to invest often do
so on the last trading day. Any buying interest in small stocks most
likely would be felt more dramatically than in large stocks.
A final general comment: Keep your eyes on what is happening the first
two weeks of January. Since I've been in the business, it has given me
certain indicators as to what the year will be like. I have found that
people who invested early in January have done well if the indication
was up. Even in 1987 when the US markets fell approximately 25% October
19 still ended up with a reasonable profit by year end.
One notable exception to the general upward trend in January I remember
well was 1990. Almost from the very first week, the TSE started heading
down. Except for a bit of an upturn in the early
summer, it went from approximately 4000 all the way down to 3000 by late
September with a slight recovery late in the year to a little over 3200.
It was the worst year since 1974. I saw it begin to happen & transferred
all our equity holdings in our RRSP to bond funds. Not only did we save
approximately a 30% decline but over the next two years tacked on
another approximately 40%.So watch carefully the markets' direction
early in the year. It may help you in your decisions. It's not 100%
accurate but just another indicator that has a good batting average.
Peak equity dates can come early in the January Effect period. Investors
showing substantial early gains in equity might consider taking their
proceeds to the bank. I prefer to look at the stock market in the long
term and keep himself open for more pressing matters. I think people who
are trying to capture the January effect are people who tend to play the
swings. If you do that, you sit around the office on Friday and you
don't play golf. And many of you know how I would hate to miss my golf.
If you have any questions, please call Reg Borrow at (519) 855-6639. He is an Independent Financial
Consultant with Regal Capital Planners Ltd.
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