With candles lit and bells ringing in the holiday season, I am here to tell you that the new year is here now! I see in my mind’s eye legions of readers dropping this magazine to the floor and running for the door to finish up holiday shopping, or better yet, pick up apology cards for missed holiday obligations. Stop. Keep reading. You’re safe.
I’m talking about the stock market and what is known as the January Effect, which—I know it sounds bold—mostly happens in December (if not even earlier). Now I feel better, ’cause it’s off my chest and out in the open, and you still have time for last minute gift buying.
All kidding aside, the January Effect is an event that has been historically tracked through many market cycles. At the end of each year and into the following, small company stocks tend to move up faster than the bigger so-called “blue chip” stocks. For example, the big stock index may be up 3 percent during this period, but the small stock index would gain 4.5 percent. Looking further at the indexes that track these groups shows that small stocks do better during weak times, but tend to lag during upward trending markets. This may not be all that surprising given that up markets are largely defined by movement in the big stock indexes, such as the Dow Jones Industrial Average and the S&P 500.
We’re not dealing with magic, astrology, or even the politics of hope here. There are some practical reasons for the outperformance of the small stocks at year’s end. Many large company stocks have distributions, such as dividends, splits, or other gains that are allocated to shareholders in the fall. Investors may tend to hold onto the more mature issues until after these distributions. Couple that with the fact that many small stocks can be volatile, and it is not unusual for investors to sell losers in the fall to take tax losses or gains. The selling can push prices down and create bargains for savvy investors. Those glandular shoppers, who buy mostly on whim, will be gone from the market, so the bargains are all for you when autumn leaves fall.
Investors have until the end of December to make tax decisions. It was originally noticed that the selling pressure abated then, and the buying began as the New Year dashed out of the gate. Studies show that from 1953, forty out of the next forty-three years saw small stocks quadruple the return of their bigger siblings during this January period. From 1979 to 2006, the small stock index rose an average of 2.5 percent during the month of January, but rose a whopping 4.7 percent from mid-December to mid-January. Clearly, buyers are jumping the gun and participating in the January Effect in December. A watchful eye might find the small group moving up as early as October. Maybe we ought to change its name. How about sending it up to Washington for a renaming? Of course, it would come back named the 406-B Effect, with taxes and administrative fees. The name would only be effective for five years and then revert back to the old name, unless the 49ers won the NFC championship in an odd year. This is not funny!
Another Wall Street yardstick is the Santa Claus Rally. A large company index was tracked for fifty-five years beginning in 1950 and revealed an average gain of 1.5 percent within the last five days of December and the first two days of January. When this rally occurs, it tends to be a good sign for the coming year. When the Santa Claus Rally fizzles, it tends to signal a weak trend for the rest of the year. (Seems the gifts of the jolly man don’t only affect small children.)
The Santa Claus Rally is part of the January Effect, but not part of the Super Bowl Syndrome, which I’ll tell you about next year. Happy holidays!
Rick Glaze’s first novel, The Middle Fork, was published in May. He is the president of Glaze Capital Management of Los Altos as well as a General Securities Principal offering securities through First Allied Securities, member FINRA/SIPC. Past performance is not an indicator of future gains.
