For decades, a popular theory has been that the increase in the USA stock market in January is often higher than in other months. This phenomenon is known as the 'January Effect,' as studies indicate that the increase in January is several times the average of other months. This effect is most pronounced in Small Cap stocks from the 1940s to the mid-1970s. However, around the year 2000, this increase appears to have contracted and has become less reliable since then.

What is the origin of the January Effect theory?

It is generally believed that the market anomalies in January were discovered by investment banker Sidney Wachtel. He operated a financial company named after himself and found the outstanding performance in January in 1942. By observing about 20 years of data, he noted that small-cap stocks tend to rise in January and perform significantly better than large-cap stocks.

Subsequent studies confirmed this anomaly. In 1976, a pioneering study of weighted price indices like the New York Stock Exchange found that the average ROI in January was 3.5%, while the average ROI in other months was 0.5%, with research data dating back to 1904. Solomon Smith Barney studied market data from 1972 to 2000 and found a smaller but still measurable effect. According to several studies, this effect gradually disappeared after 2000.

Data compiled by Bloomberg shows that in the 30 years starting from the mid-1980s, the benchmark for Small Cap stocks in January has an average increase of 1.7%, making it the second best-performing month of the year. $Russell 2000 Index (.RUT.US)$ However, since 2014, as people's awareness of this has increased.$Amazon (AMZN.US)$With the frenzy surrounding large Technology stocks like Google (GOOGL.US), the Index saw an average increase of only 0.1% in January.

How to explain the "January Effect"?

The 'January Effect' has been widely accepted for decades, to the point that most studies focus on trying to find nuances and reasons without reaching any definitive conclusions. However, there are other theories. The main theory is that many individual investors engage in tax-loss harvesting in December, selling off losing positions to offset gains and reduce their tax liabilities.

This theory suggests that after January 1, investors will stop selling and replenish their stock portfolios, driving the market upward. Another theory is behavioral: people make financial decisions at the beginning of the new year and adjust their investments accordingly, pushing the market higher. Many high-salary investors rely heavily on year-end bonuses, giving them ample Cash to invest at the start of the new year.

What is different about this January?

Following a significant sell-off in the last few trading days of last year, the US stock market is starting 2025 in turmoil. The turbulence indicates that the market is responding to the Federal Reserve's plans to slow the pace of interest rate cuts. Despite this,$Russell 2000 Index (.RUT.US)$In December of last year, it plummeted by 8.4%, marking the worst monthly performance since September 2022, which may lead to a rebound in these battered Stocks in the coming weeks. It is expected that Small Cap will achieve double-digit profit growth later this year; these companies typically benefit from interest rate cuts.

Are there other market theories about the January Effect?

Yale Hirsch first introduced the so-called "January Barometer" theory in 1972, which posits that January's performance predicts the performance for the entire year. If the stock market rises in January, it is expected to rise by year-end, and vice versa - for example, in 2022, the market experienced sell-offs in January, leading to a bear market later that year. Although some analyses suggest that from 1950 to 2021, this theory held true 85% of the time, critics argue that this correlation is merely coincidental, since the stock market tends to rise about three-quarters of the time during that period.

Additionally, the "January Triple Win" theory indicates that the first five trading days of January, the entire month, and the so-called Christmas rally predict the performance for the upcoming year.

Why might the January Effect fade?

One theory suggests that the market has already taken into account the impact of January and has made some adjustments, making this effect undetectable. Another theory argues that the market is shifting focus more towards Large Cap Technology stocks, weakening the "January effect." This shift started around the turn of the millennium, coinciding with the rise of index funds and ETFs, as investors rushed to buy what were called the "Four Horsemen" of the late 1990s:$Microsoft (MSFT.US)$、 $Intel (INTC.US)$ 、$Cisco (CSCO.US)$and $Dell Technologies (DELL.US)$ (Dell Technologies was later privatized and subsequently re-listed).

According to data from Stock Trader's Almanac, from 1979 to 2001, the E-mini Russell 2000 Index outperformed the Large Cap Russell 1000 Index by an average of 3.4% from mid-December to mid-February. Since then, the average ROI of the E-mini Russell 2000 Index has been only about 1% higher than that of the Large Cap Index.

Editor/Rocky