The January Effect is a theorized market anomaly where equity market prices are believed to spike more during January as compared to the rest of the year. The January Effect origin dates back to 1942 where investment banker Sidney B. Wachtel started digging into this hypothesis. As this theory evolved, it became more focused on how small-cap companies have a tendency to outperform large-cap counterparts during the month. Market participants still debate on whether the January Effect is still relevant in today’s markets. Some believe it has become such a minor event it should be disregarded altogether. Their thoughts are that if this anomaly existed, it would have been arbitraged away by investors purchasing issues in December.
Before we look at historical index performance and fund flows, let’s dig into the supposed drivers of this hypothesis. First and foremost, investors’ tax planning often leads to a selloff of their underperforming stocks in December. Through selling the losers in their portfolio, investors lock in a loss which will reduce any capital gains for the year and thus decrease their overall tax bill. In January, those investors flood money back into the market and buy back into their positions (or new ones). Portfolio rebalancing is another potential factor for the January Effect. It has been argued that portfolio managers “window dress” their portfolios by selling riskier positions at the end of the calendar, oftentimes those riskier positions are smaller-cap companies. Then once the new year begins, the managers reallocate back to riskier (small-cap) issues. There are also theories of investor psychology and even market participants investing recently acquired year-end bonuses at play. The jury is still out on whether the January Effect is a real anomaly or even material enough to matter.
The data used here shows monthly averages for both performance and fund flows dating back to 2000. In those 22 monthly periods, the NASDAQ (+0.77%) and Russell 2000 (+0.10%) have averaged plus-side performance in January—this compares to their overall monthly average (in that same time frame) of positive 0.71% and positive 0.74%, respectively. The S&P 500 (-0.33%) has averaged negative performance over those same 22 Januarys compared to its overall monthly average of positive 0.54%. Performance-wise, small-caps have outperformed at least the S&P 500, on average, in the past 22 Januarys.
Fund flows (including both conventional and ETFs) tell an interesting story. The average monthly fund flows for equity and fixed income funds in December are negative $7.3 billion and negative $1.6 billion, respectively. Money market funds, however, see a significant influx of cash during the last two months of the year. Since 2000, money market funds, on average, attract $34.9 billion in capital in December.
Once the new year comes, capital has flown back into equities and fixed income funds. Since 2000, both equity and fixed income funds average their largest monthly intake over a calendar year. Equity funds attract, on average, $17.3 billion in January (versus their $5.6 billion overall monthly average). Fixed income funds pull in, on average, $25.3 billion during the month (compared to their $14.2 billion overall monthly average). In both cases, each asset class’ largest monthly inflow has occurred in January. Money market funds, on the other hand, have averaged $400 million in outflows during the first calendar month of the year since 2000. Whether the January Effect is any indication of stock performance is still up in the air, but it would appear fund flows indeed have a strong relationship to the beginning and end of a calendar year.
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