January can be a time for optimism: new year, clean slate, firm resolutions, endless possibilities. It's natural to wonder whether that sunny outlook extends to the stock market. Enough people believe it does, and that belief has been elevated to something approaching conventional wisdom. As with a lot of conventional wisdom, though, the truth is debatable.
The personal finance press has a catchy nickname for everything, including the belief that stocks will rise after the first of the year. They call it the "January effect." As markets writer Adam Shell of "USA Today" explains it, one theory holds that investors brimming with optimism pour their money into the stock market, driving prices up. Other investors, hoping to get in on the gains spurred by that fresh cash, hop into the market to ride the wave, and away we go.
Another theory behind the January effect lays the credit -- or, really, the blame -- on Uncle Sam. Investors who sell stock at a profit have to pay capital gains taxes on their profit. However, you can offset your capital gains in a given year with capital losses incurred in the same year. As the year comes to an end, stock investors hoping to reduce their taxable gains start selling some of the duds in their portfolio so they can report those losses against their gains. That, the theory goes, pushes stock prices down in December. That artificial low is then followed by a rebound, and, voila, the January effect.
When you start looking at hard data rather than hazy theories, the January effect gets harder to find. According to data compiled by the Federal Reserve Bank of St. Louis, the Dow Jones industrial average and the S&P 500 -- two of the most widely cited measures of the general mood of the markets -- both tend to rise in January. Over 20 years from 1994 to 2013, for example, the Dow rose an average of 0.3 percent in January, and the S&P 500 rose an average of 0.5 percent. Some January effect! But wait: Over the same period, the average gain for the Dow in all months was 0.7 percent, while that of the S&P 500 was 0.6 percent. How about that February-through-December effect! Meanwhile, Jim Brown of the "Premier Investor Newsletter" says his review of January data finds that the market is equally likely to rise or fall not only in the first month of a new year, but also in the first week and on the very first day.
"Barron's" magazine points out that the January effect is less a market-wide phenomenon than something you see with individual stocks -- if a stock takes the beating in December. Tom Aspray, who writes for the "Forbes" and MoneyShow websites, acknowledges a January effect but says doesn't apply to all stocks, and it doesn't even necessarily occur in January. He says the stocks that are sold off at year's end tend to be "small-caps" -- stocks of relatively small companies, which don't show up in the Dow, the S&P or the other most commonly cited market indexes. Further, once the sell-off occurs, there's no reason the rebound (if there is one) can't occur before New Year's, in which case the January effect is actually a December effect.
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