Causes of the January Effect on Share Prices

The January Effect is the term used to describe New Year rises in share prices on the world’s Stock Markets. It’s a general rise across the spectrum of shares, although it tends to be more evident in small capital stocks rather than higher ticket shares. It was identified as a market anomaly as long ago as 1942 by investment banker Sidney B. Watchel, based on his observations on movements on the Wall Street Market, although the term ‘January Effect’ is believed to be the brainchild of  Donald Kiem of the University of Chicago. These are just some of the causes of the January Effect

December sell-offs

Shareholders with large portfolios tend to sell off their shares at the end of the year to bring about tax losses in order to avoid Capital Gains Tax (CGT). December sell-offs push down the prices of shares slightly, which makes them more attractive to January buyers. However, as it’s possible to place shares in tax shelters such as retirement plans, this is not thought to be such a significant cause nowadays.

New Year, new start

The New Year is traditionally a period of optimism, and even investors who have had poor returns on their shares in the previous year may be in the market to buy more shares. There’s a tendency to draw a line and start over.

Activity by fund managers

Some fund managers with an eye on the market may buy more shares in late December when the market is quiet. This serves to boost prices, and some commentators suggest it may also be a tactic employed by fund managers to increase their year end bonuses.

Retail investor behaviour

Retail investors tend to favour small capital stocks, and they also tend to be active in the markets in January, so this could be a contributory cause of the January Effect. Recent research certainly seems to indicate that retail investor activity has some influence on the Australian Stock Market. As a class of investors, retailers tend to concentrate on small capital stocks more than any other group in Australia, and this behaviour may be repeated in other countries.

Year end bonus payments

January is the time when year end bonuses are paid out, and a large number of the recipients of these bonuses may use part or all of their payment to buy more shares. This activity helps to drive up share prices, adding to the so-called January Effect.

It should be noted that all of these causes, while making some contributions the January Effect on share prices, do not have impressive consequences on share prices, one way or another. These days, those who influence stock market movements expect this anomaly and take compensatory measures to offset its effects. Nevertheless, it is an interesting characteristic which challenges and intrigues market watchers every year.