What's Up With "The January Effect"?   written by Anne Easton

At the start of every calendar year, investors — some still full from turkey leftovers or New Year's Eve champagne often eagerly anticipate a rise in stock prices.

That's largely due to what's known as the "January Effect." It's a term used to describe an expected seasonal increase in stock prices at the beginning of the calendar year. The phenomenon, which helps shed light on the cyclicality or seasonality of investment habits, has been linked to an increase in buying after the so-called December decline.

How does it work?

While some of us think of December as an uplifting time — perhaps hunting for presents to place under a perfectly decorated tree or frying savoury potato latkes in a liberal amount of oil  markets often have other ideas.

At the end of the year, stock prices can sometimes drop as some investors look to limit their tax bills by selling off some of their investments. This sell-off can then become a stock rally in January as the year resets and investors, sometimes flush with year-end bonuses or perhaps a well-intentioned financial resolution, decide to purchase anew.

Investment banker Sidney B. Wachtel is said to have been the first to highlight this calendar-based phenomenon in 1942, when he examined stock prices going back to 1925 and found that certain small stocks outperformed the market in January. But over time, this effect is believed to have become less significant. While one study that analyzed data through the mid-70s found that the average return for stocks in January was five times that of any other month, more recent studies have found a smaller impact.

What does it mean for me?

While the January Effect might seem for some like an annual opportunity to sell high in the New Year, a Reuters article in 2017 noted that a Goldman Sachs analysis of returns since 1999 found that the January Effect had faded compared to periods going back to 1974. But some suggest there is a strong psychological component that still drives a January buying spree: Many people believe that the new year is good time to start something — including making changes to their investment portfolio. Still, any decisions to buy or sell are best backed by research, a solid understanding of your investing style and account types that are right for you, and any related tax implications for specific holdings.

The takeaway?

This particular phenomenon is a good reminder that investors should be mindful that markets don't always perform the way one might expect — they can be subject to prevailing trends and cycles, economic and political influences, for example. That also means the old investing adage, "As January goes, so goes the year," might just need to be taken with a grain of salt.

The information provided in this article is for general purposes only and does not constitute personal financial advice. Please consult with your own professional advisor to discuss your specific financial and tax needs.

Source - written by Anne Easton, published on January 2 2022 in the RBC Inspired investor newsletter. 
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