US stocks start tumultuously in 2025, can the "January effect" be replicated?
The increase in the U.S. stock market in January is usually higher than in other months, a phenomenon known as the "January Effect." Historical data shows that from 1940 to the mid-1970s, small-cap stocks performed particularly well in January, but this phenomenon has gradually weakened since 2000. Research indicates that the average return in January is 3.5%, while in other months it is only 0.5%. In recent years, with the rise of large technology stocks, the gains of small-cap stocks in January have significantly decreased, averaging only 0.1%
According to the Zhitong Finance APP, for decades, a popular theory has suggested that the U.S. stock market tends to rise more in January than in other months. This phenomenon is known as the "January Effect," as studies have shown that the gains in January are several times the average of other months. This effect was most pronounced in small-cap stocks from 1940 to the mid-1970s. However, around the year 2000, this gain seemed to shrink and has since become less reliable.
What is the origin of the January Effect theory?
It is widely believed that the January market anomaly was discovered by investment banker Sidney Wachtel. He ran a financial company named after himself and discovered the exceptional performance in January in 1942. By observing about 20 years of data, he found that small-cap stocks often rose in January and performed significantly better than large-cap stocks.
Subsequent studies confirmed this anomaly. In 1976, a groundbreaking study of weighted price indices such as the New York Stock Exchange found that the average return in January was 3.5%, while the average return in other months was 0.5%, with data traceable back to 1904. Solomon Brothers studied market data from 1972 to 2000 and found a smaller but still measurable effect. According to several studies, this effect gradually disappeared after 2000.
Data compiled by Bloomberg shows that over the 30 years starting from the mid-1980s, the small-cap benchmark Russell 2000 index had an average gain of 1.7% in January, making it the second-best performing month of the year. However, since 2014, with the frenzy surrounding large tech stocks like Amazon (AMZN.US) and Google (GOOGL.US), the index's average gain in January has only been 0.1%.
How to explain the "January Effect"?
The "January Effect" has been widely accepted for decades, to the extent that most research has focused on trying to find nuances and reasons without reaching any definitive conclusions. However, there are other theories. The main theory is that many individual investors engage in tax-loss harvesting in December, selling off losing positions to offset gains and reduce tax liabilities. This theory posits that after January 1, investors stop selling and replenish their stock portfolios, driving the market up. Another theory is behavioral: people make financial decisions at the beginning of the new year and adjust their investments accordingly, thus pushing the market higher. Many high-paid investors heavily rely on year-end bonuses, giving them ample cash to invest at the start of the new year.
What is different this January?
Following significant sell-offs in the last few trading days of last year, the U.S. stock market has had a turbulent start in 2025. The turbulence indicates that the market is grappling with the Federal Reserve's plans to slow down interest rate cuts. Nevertheless, the Russell 2000 index plummeted 8.4% in December, marking the worst monthly performance since September 2022, which may allow these battered stocks to rebound in the coming weeks. Small-cap stocks are expected to achieve double-digit earnings growth later this year; these companies typically benefit from interest rate cuts Are there other market theories regarding the January effect?
Yale Hirsch first proposed the so-called "January Barometer" theory in 1972, which suggests that January's performance predicts the performance for the entire year. If the stock market rises in January, it is expected to rise by the end of the year, and vice versa— for example, in 2022, the stock market experienced a sell-off in January, leading to a bear market later that year. Although some analyses indicate that this theory held true 85% of the time from 1950 to 2021, critics argue that this correlation is merely coincidental, as the stock market was up about three-quarters of the time during the same period.
Additionally, the "January Three-Win" theory posits that the performance of the first five trading days of January, the entire month of January, and the so-called Christmas rally predicts the performance for the upcoming year.
Why is the January effect fading?
One theory suggests that the market has already accounted for January's impact and has made adjustments, rendering this effect undetectable. Another theory posits that the market is changing, with increased focus on large tech stocks, which is diminishing the "January effect." This shift began at the turn of the millennium, coinciding with the rise of index funds and ETFs, as investors rushed to buy the so-called "Four Horsemen" of the late 1990s: Microsoft (MSFT.US), Intel (INTC.US), Cisco (CSCO.US), and Dell (which was later privatized and then relisted). According to Stock Trader's Almanac, from 1979 to 2001, the Russell 2000 index outperformed the Russell 1000 large-cap index by an average of 3.4% during the period from mid-December to mid-February. Since then, the average return of the Russell 2000 index has only been about 1% higher than that of the large-cap index