The January Effect and Portfolio Management Tools


Please note: following is a discussion of certain seasonality phenomena that you might find interesting, but past performance is not indicative of future returns. This discussion should not be construed as a recommendation to buy or sell a security or to provide investment advice For investment advice please check with your financial advisor.

This website uses a new term "December/January Effect" to refer generally to interesting results re: small-cap stock performance near year-end. Investors have used the term "January effect" to refer to the phenomenon in which small-cap securities often have had higher rates of return than large-cap stocks in the January months in the 20th Century.

Perhaps because the "January Effect" has been so well publicized over the past decade or two, the January Effect has been well-anticipated and the Russell 2000 outperformed the Russell 1000 by more than five percentage points in the three Decembers from 1999 through 2001. Some observers now believe that the January Effect might have disappeared for most small-cap stocks, but at least one writer has suggested that the phenomenon might still persist for very small microcap stocks.

The CBOE is the only exchange where investors can access options on all these indexes (and dozens more index options) to help manage their portfolios:

Overview of the January Effect

The "January effect" has been used to refer to the phenomenon in which small-cap securities often have had higher rates of return in past Januarys than large-cap stocks. The effect was first suggested in 1942, and widely publicized in the past 25 years by scholarly articles and a popular book entitled The Incredible January Effect: The Stock Market's Unsolved Mystery, by Robert A. Haugen and Josef Lakonishok. Perhaps due in part to publicity and anticipation of the effect, the January effect has weakened in recent years.

There are a number of theories as to why the January effect has occurred. Some people speculate that it may be related to the many year-end research reports on the small-cap market, which can make these stocks look like attractive places to put money. Another theory says that investors who need cash for the holiday season will sell some holdings; bargain hunters then swoop in to buy the sold-off shares. Others believe the effect may be related to tax-motivated selling and buying -- fund managers might rush to buy back all those money-losing stocks they had previously sold to meet the tax-loss deadline. See the bibliography below for more details.

Growing Volume for IWM Options

Microcap Performance Over 77 Years

One recent article suggested that:

  1. The January effect remains either dead or dormant for all but the smallest firms.
  2. The January effect in these stocks survives even after we account for a large list of risk factors.
  3. While it hasn't been figured out how to effectively exploit this little anomaly yet, there still appears to be time."
Pietranico, Paul-Charles and Mark W. Riepe. "The January Effect Revisited."

Journal of Financial Planning. (Apr 2004) pg. 26.

The graph below shows that the stocks in the 10th decile (with very small capitalizations) outperformed the 1st decile (very-large-capitalization) stocks in 70 of the 77 Januarys from 1926 to 2002.

From 1926 through 2002, the smallest 10% of all stocks (or "10th decile") beat the 1st decile stocks by an average of 9.35 percentage points in the month of January.

If you have an interest in microcap stocks, you might explore the use of the new CBOE options on the iShares Russell Microcap Index Fund (IWC).

Options and Portfolio Management Strategies

An investor who has studied the December/January effect could visit the links below for more on options strategies to help implement his trading decisions:

Bibliography of Articles on Seasonality and the January Effect

Ball, R., S.P. Kothari, and J. Shanken, "Problems in Measuring Portfolio Performance: An Application to Contrarian Investment Strategies," Journal of Financial Economics (May 1995), 79-107.

Barnhart, Bill. Small Caps Get a Jump on January Effect," Chicago Tribune. (Dec 5, 2004).

Bhabra, Harjeet S. et al.; "A November Effect? Revisiting the Tax-loss-selling Hypothesis." Financial Management (Winter 1999)

Chen, Honghui, and Singal, Vijay. "A December Effect with Tax-gain Selling?" Financial Analysts Journal. (Jul/Aug 2003), pg. 78.

Chopra, N., J. Lakonishok, and J.R. Ritter, "Measuring Abnormal Performance: Do Stocks Overreact?" Journal of Financial Economics (April 1992), 235-268.

Haugen, R.A. and J. Lakonishok, The Incredible January Effect: The Stock Market's Unsolved Mystery, Homewood, IL, Dow-Jones, Irwin (1998).

Hulbert, Mark. "Why Small-Cap Stocks Are So Hot in Cold Weather." New York Times. (Nov 18, 2001).

Jones, S.L., W. Lee, and R. Apenbrink, "New Evidence on the January Effect Before Personal Income Taxes," Journal of Finance (December 1991).

Keim, D.B., "Size-Related Anomalies and Stock Return Seasonality: Further Empirical Evidence," Journal of Financial Economics (June 1983), 12-32.

Lakonishok, J. and S. Smidt, "Volume for Winners and Losers: Taxation and Other Motives for Stock Trading," Journal of Finance (September 1986), 951-974.

Maxwell, W., "The January Effect in the Corporate Bond Market: A Systematic Examination," Financial Management (Summer 1998), 18-30.

Opdyke, Jeff. "Only Three Weeks Left To Fix Your Portfolio --- Stock Losses Hit a Record This Year, but December May Be the Time to Buy; the Real 'January Effect.'" Wall Street Journal. (Dec 11, 2002). pg. D.1

Pietranico, Paul-Charles and Mark W Riepe. "The January Effect Revisited." Journal of Financial Planning. (Apr 2004) pg. 26.

Pradhuman, Satya Dev. Small-Cap Dynamics: Insights, Analysis, and Models. 2000.

Riepe, Mark W. "The January Effect: Not Dead Yet, but Not at all Well." Journal of Financial Planning. v. 14 no1 (Jan. 2001).

Roll, R., "Vas Ist Das? The Turn of the Year Effect and the Return Premia of Small Firms," Journal of Portfolio Management (Winter 1983), 18-28.

Shell, Adam. "Are Too Many Investors Discovering January Effect?". USA Today. Nov 30, 2004. pg. B.1.

Stires, David. "Cashing in on the January Effect." Fortune (Nov. 27 2000).

Wachtel, S., "Certain Observations on Seasonal Movement in Stock Prices," Journal of Business (April 1942).

Yanxiang Gu, Anthony. "The Declining January Effect: Evidences from the U.S. Equity Markets." Quarterly Review of Economics and Finance. (Summer 2003) pg. 395.

Zweig, Jason. "New Year's Play". Money (Dec. 2000)