ETFZone.com
The January Effect: How Significant Is It?
Tuesday December 28, 1:51 am ET
By Jonathan Bernstein, ETFzone Trading Specialist
Every season on Wall Street has its themes and memes. Going into a new year, one of the best-known seasonal themes is the so-called January Effect. According to the January Effect, stocks go up in January because investors sell in December for tax purposes and then put money back into the market in January. If this is so then, the inflow of money into the markets in January should make this a good time to own stock. The January Effect is said to affect small cap stocks more than large cap stocks because a relatively small amount of tax loss selling in December has a larger impact on small or thinly traded stocks.
How significant is the January effect, and if it is significant, is there an opportunity for ETF investors to take advantage of it?
Review of 17 years of data (from 1988-2004) on the small-cap focused Russell 2000, as well as the large-cap S&P 500 and Dow Jones Industrial Average (DJIA) yields the following results:
INDEX Mean January Return Mean of the Yearly Returns from 1988-2004 Mean January Return as a percentage of Mean Yearly Returns
Russell 2000 1.56% 12.08% 12.92%
S&P 500 1.54% 11.15% 11.70%
DJIA 1.13% 9.46% 11.91%
In order to calculate the 2004 data, end of the year numbers of 11,000 on the DJIA, 650 on the Russell and 1210 on the S&P are used.
As the table above shows, investing in January only in the past few decades has returned an average of over 1% on the Dow Jones Industrial Average and over 1.5% on the S&P 500 and Russell 2000. This is about 50% higher than the average return for all months on these indexes.
Superior returns do not come without risk. Though on aggregate January has been a good month to own stock, not every January is a winner. The table below shows the number of times since 1988 these indexes have been positive, the number of times they have been negative, and the average January gain or loss during those years.
INDEX UP Januarys DOWN Januarys Average Gain in an UP Year Average Loss in a DOWN Year
Russell 2000 10 7 4.43% -2.54%
S&P 500 12 5 3.43% -3.82%
DJIA 12 5 2.87% -3.06%
As the above table indicates, the Russell 2000, despite having the best January on a percentage performance basis, has had more down Januaries than the S&P 500 or DJIA. The Russell 2000 achieves better January results on aggregate by significantly outperforming during the years when January is positive.
On whether the January Effect affects small caps more than large caps, the above data indicates that there may be a slight effect. The Russell 2000 Index outperformed both the large cap S&P and the Dow Jones Indexes. But this effect is less remarkable than the overall strong historical performance of stocks in January. Since 1988, January has on aggregate been a good month for small-cap, mid-cap and large-cap issues.
For an ETF investor who wants to invest in an index to take advantage of the January Effect, there are many possibilities. For investors interested in small cap issues, the iShares Russell 2000 Index (AMEX:IWM - News) tracks the iShares Russell 2000, a popular small cap index. Standard and PoorÂ's Depositary Receipts (AMEX:SPY - News) tracks the ubiquitous S&P 500 Index of large caps. The Diamonds Trust (AMEX:DIA - News) tracks the eminent Dow Jones Industrial Average of blue-chip large caps, which tend to have a value orientation. There are a myriad of other suitable broad-market ETFs.
Although January has overall been a good month to own stock, this may not be the case in January 2005. November and December of 2004 have been exceptionally strong months for broad market ETFs. Many market watchers believe the market is out of steam and that this is the January to sit it out.
Jonathan Bernstein has specialized in short-term trading of equities and equity options since 1998.
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