The January Effect is a rise in stock prices often witnessed throughout the month of January. According to the theory, stock prices usually drop in December and surge in January. How could the January Effect impact stocks? Could the January Effect set the stage for a bull market in 2021?
The January Effect creates an opportunity for investors to purchase stocks for lower prices before January and sell them after the stock price increases. Since 1950, the S&P 500 Index has generated an average gain of 1.8 percent in January compared to 0.7 percent in other months.
The January Effect hypothesis
The January Effect is a hypothesis that there's a seasonal phenomenon in the financial market where stock prices rise more in January compared to the other months. Mainly, there's heavy selling in December and aggressive buying in January, specifically early in the month. From 1928 to 2018, the S&P 500 Index rose 62 percent of the time in January.
The January Effect is mainly driven by tax planning. Investors tend to sell losing stocks at the end of the fiscal year to mitigate their upcoming capital gains taxes, which can depress stock prices. At the beginning of the new calendar year, the investors buy the stocks back, which pushes up stock prices again.
January Effect was early in 2020 amid the COVID-19 pandemic
The January Effect came early in 2020 amid the COVID-19 pandemic, according to Jefferies strategists. “We think an early January Effect is driven by the fact that investors may be reluctant to sell their winners while in their 2020 fiscal year and generate a large capital gains tax when it has been a tough year,” Jefferies analysts said. “They may be holding onto these gains until their fiscal years roll to 2021 and for many funds, that date is October 31st.”
Stock market in January 2021
The stock market ended 2020 with an all-time high on the last day of the year. In 2020, the S&P 500 and the Nasdaq Composite gained 16.3 percent and 44 percent. January 2021 could be choppy due to rising coronavirus infections and deaths nationwide. The month started with the U.S. Senate runoff election in Georgia, which provided additional market volatility.
Also, January 2021 will end with earnings season for the fourth quarter of 2020. Wall Street analysts expect the third biggest year-over-year drop for S&P 500 earnings since 2009.
Investors can take advantage of the January Effect
Investors can benefit from the January Effect by buying shares of stocks that lost big the previous year. The two stocks that could turn the corner in 2021 are Intel and Boston Scientific. In 2020, Intel delayed product launches. Also, weak management allowed competitors to pick up market share. Boston Scientific has reported weak or negative growth in the past three quarters. In the last year, Intel and Boston Scientific stocks have fallen 14.1 percent and 20.2 percent, respectively.