The January Effect

January 6, 2021

            With 2020 coming to a close, many have been asking what is in store for the market in the year 2021. The past year has been very tumultuous for the market and the economy as a whole, and many are ready for it to be over. In order to ponder what is in store for the coming year, it is necessary for us to review the past year and how previous recoveries proceeded.

            In 2020, Murphy’s Law seemed to definitively take hold: that is, everything that could go wrong, did go wrong. We experienced a global pandemic, riots stemming from social issues, and possibly the most controversial Presidential Election In history. Markets bottomed out near the end of March and completed a miraculous recovery largely due to the influx of stimulus into the economy. This stimulus allowed corporations in affected industries to stay afloat until there was a semblance of a return to normal.

            As we enter 2021, there is a sense of optimism in the financial markets. The vaccines from Pfizer and Moderna have begun being distributed in most of the developed world, leading many to believe that most industries will be able to fully resume by mid-year. However, things will not get “back to normal” as many have put it. The pandemic forced businesses to adapt to unique circumstances and in many cases has led to the advent of new technologies and work processes which are more efficient, even in non-pandemic situations. In order to see what 2021 will bring with regards to the performance of the market, it is important to look at previous recoveries to see where we are at.

            In the third quarter of 2020, the US economy grew 33% and effectively ended the coronavirus induced recession that began in the first quarter of the year. At the same time, this also began the official recovery period which we can look to in order to gain some insight. The previous four economic recoveries lasted at least four years, which gives an indication that the US economy may have a fairly long economic expansion ahead of us. Despite elevated stock prices and already corporate earnings numbers that are already quite lofty, the possibility of an expansion last several years gives reason for investors to stay invested.

            While many are indeed optimistic, we think that it is important to stay cautious during these volatile times. we hope the expansion happens, but the market is at an all-time high, and as such it is prudent to be careful.  Therefore, we have added in daily essentials and stocks that have strong balance sheets.  In our Kings model we have increased those holdings and international

While some might think the January Effect has to do with setting a New Year’s resolution in January and then in giving up on it in February, most investors understand the January Effect to be the theory used to describe why stocks tend to go up in January.
The January Effect is a market-wide theory that suggests people tend to buy the stocks back in January that they sold in December for tax purposes. Investors tend to sell underperforming stocks in December in an effort to minimize their tax bill by offsetting the capital gains they would have paid on stocks that did perform well, with loses incurred on stocks that didn’t perform well.   Then, if the investor really wanted to own the stock, they might buy it back at the beginning of the year, often times in January.
However, many investors and industry pundits refute that fact the January Effect exists. For a calendar-based anomaly like that to regularly occur, would indicate that markets are in-efficient. This would refute modern portfolio theory that has been established since the 1960s. Additionally, if an in-efficient market would exist, investors would simply invest in January in anticipation of an outsized return.
Regarding the January Effect, the truth seems to be somewhere in the middle. While the January Effect doesn’t seem to be as pronounced as it was in the early 20th century before the Internet, there does seem to be evidence supporting a seasonal change in markets between December and January. For instance, in December 2019 the Dow Jones Industrial Average went from 28,645.26 on December 27th, to 28,462.14 on December 30th, back up to almost 400 points on January 2nd, 2020 to 28,868.80.
While the example above does support the existence of the January Effect, it is still unclear whether an investor could benefit from such an occurrence on a regular basis. However, one thing we do know is that from 1928 through 2018, the S&P rose 62% of the time in January, or 56 out of the 91 years, according to Investopedia.
Regardless of whether the January Effect really does exist, its’ most important to focus on the fundamentals of your investment strategy such as asset allocation, risk tolerance and time horizon when making investment decisions and not unreliable seasonal anomalies like this year’s resolutions!