The January Effect

I learned this at work the other day and thought I would share. Turns out taxes do more than just take your money away. The January effect is a bounce in stock prices in January due to the absence of abnormal selling pressure taxes create. This does not happen in all stocks; you see the most results from small cap stocks that have gotten beaten down during the previous year, although mid to larger cap stocks are affected also, just not as much. There are a couple reasons for this phenomena. First is because of window dressing from professional investors that manage large funds. They eliminate their losses from their portfolio and add winners to improve their perceived performance. This is because professional investors are evaluated on both their investment results and consistency of their investment philosophy. This also occurs at the end of each quarter because of professional investors; however, it does not result in the same increase in stock prices. The second reason is because of abnormal selling pressure prior to the end of the year. This pressure is a result of taxes. People/investors want to sell their stocks that have lost them money during the year to obtain the tax losses. Thus, towards the end of the year everyone sells their losers which causes them to go down more. When the New Year begins there is no abnormal selling pressure from taxes. This lack of selling pressure results in increased prices of stocks that were affected from the abnormal selling pressure. The bounce usually occurs within the first 10 – 14 days of the year. If no bounce occurs within the first two weeks, there usually will not be a bounce. Here is a good example of the January Effect on Las Vegas Sands Corp (LVS). Back In 2005 LVS hit a high of $49.05 in Feb; hit its low of $31.37 in Oct.; rebounded to 45.51 on Nov 25 and closed two weeks later at $38.73. This decrease could have resulted from the abnormal selling pressure. The last trading day of the year, Dec 30, the stock was at $39.47. By January 6, ’06 the stock price was at $41.61, by Jan 13 it was at $48.35, and by Jan 20, $49.66. After looking at past predictions for possible Jan. Effect stocks, the best way to win by using this theory is to use a basket of stocks that you have researched and that you believe could bounce in Jan. Some of our own Professors and alumni at U of I have written on the topic as well.