The January Effect

In just a few hours we will begin the last trading week of 2008.  If there is anything that this year has taught us it is that we should throw history out the window.  When we found out Madoff madeoff with billions of dollars it was just icing on the cake to a year the market would like to throw out the window in order to forget.  Decades of financial modeling was thrown out the window, or should have been at least, as we experienced what we hope is once in a lifetime market turmoil. So much for the “backtesting” that all the discount brokerage ads on tv want you to buy in to.

Every year around this time we see talks of “the January Effect”.  The January Effect is basically an observed phenomenon in which stock prices rise from the end of December through the first few weeks of the new year.  This “effect” is said to affect small capitalization companies more than mid cap or large cap companies.  The general belief is that the January Effect comes about because investors sell late in the year to create tax losses.  They buy back their positions at the beginning of the year when the tax clock resets and as a result drive prices up.

Could it happen again this year?  Sure.  But, just remember what it says in all those investment disclaimers you always skip: past performance does not guarantee future results.  The January Effect has been so widely known for so long that there is a belief that the effect has already been priced in to the market.  Furthermore, with a year like 2008 equity investors have good reason to be running scared and no one is expecting anything close to a buying frenzy.  Tax law only allows you to use $3,000 in losses to offset other income, and with the market collapse this year it doesn’t seem like anyone needed any help creating losses or needed any reason to wait for the end of the year to take them.  So, if you’re thinking the January Effect will save you this year, you might want to think again.

Monday, December 29, 2008, 00:14 | posted in the markets | 1 comment »