Early Market Optimism, Dissecting the January Effect

(epicharmus)

What is the January Effect?

With 2009 mercifully behind us, believers in a bounce-back 2010 are staking their hopes on the “January Effect.” The January Effect, for those new to the concept, refers to how securities prices tend to rise in January. The main characteristic of this phenomenon is a rush to buy securities before the end of the year for a lower price, speculating that the price will go up in January, and then selling for a profit. There is also a strain of financial opinion which holds that market performance in January (good or bad) sets the tone for the entire rest of the year. For these reasons and more, January inevitably spells heightened interest in the goings on of the stock market – especially this year, when some analysts were already cautiously optimistic about an economic recovery. Today, we’ll take a look at this investment phenomenon with an eye toward its origins, historical significance, recent results, and potential impact on 2010.

(katrina.tuliao)

When Did The January Effect Begin?

History shows that the January Effect predates its discovery by investors. As InvestmentU.com reports, “…from 1925 to 1993, small stocks beat large stocks in January in 69 of the 81 years.” Nor was it particularly close, as the return difference between big stocks (2%) and small stocks (7%) was roughly five percentage points during those same years. However, it was not until the early 1980’s when a University of Chicago grad student named Donald Keim observed this as an historical trend. Keim’s research found that not only did small stocks outperform the broader market during January, but also that the bulk of this disparity took place, “…before the middle of the month.” It was Keim who publicized the January Effect to investors at large, many of whom since came to regard January as something of a magical, once-yearly money machine.

As alluded to earlier, there are also those who see a strong or poor January as predicting the entire year. On January 5, the Chicago Tribune boldly proclaimed that the January Effect, “…often, but …