We mentioned the January effect in the December 22nd report as a positive sign resulting from the action of many stocks we have seen of late (stocks making strong moves off of the bottom of their bases and currently forming the right sides to these bases).
The January effect refers to the general tendency of the stock market to rise between the last day of December and the end of the first week in January (though the effect can sustain throughout the month, 25% of the activity historically occurs in the first week). It is generally considered to be a result of tax-related selling: many investors will sell some of their stocks (that are down) just before the end of the year to claim a capital loss on their taxes. Once the new year hits, these investors turn right around and reinvest their money in the market, which of course causes stock prices to rise in a short term, natural rebound effect. The effect is said to impact small-cap stocks more than mid- to larger-cap stocks. This better performance is an anomaly since the stocks that are usually sold are the ones that haven’t previously performed well. However, stocks of all sizes tend to benefit at the start of a year from bonus money and an influx of cash into retirement accounts.
The phenomenon that has occurred regularly throughout history (Merrill Lynch reports 70% of the time since 1926), but it’s debatable as to how much investors can profit from it if just looking at the first week in January. The possible reasons for this are two-fold: 1) the markets tend to expect it to happen and therefore have adjusted prices for it accordingly. And, the rise of stocks up the right sides of their bases over the last month or two might indicate that the effect of anticipation has pushed the buying into November and December, and 2) more people are using tax-sheltered retirement plans and thus have no reason to sell at year’s end for tax losses.