6 Stocks To Profit From The "January Effect"

Stocks posted back-to-back gains on Jan 7, igniting hopes that a revival is in the works after the most dismal December since the Great Depression. This was in keeping with the historical phenomenon known as the January Effect. This is a direct result of investors selling stocks at the end of a year in order to offset capital gains, only to redeploy funds obtained from these sales at the start of the New Year.

Tech stocks, the darlings of the bourses till last year, seem to have found fresh favor with investors. This is evident from the interest shown in Netflix’s (NFLX  - Free Report) stock, which is recovering from a dismal second half of last year. Meanwhile, bullish jobs data and trade talks are boosting retail stocks. Investing in tech and retail would enable you to make the most of this January Effect.

Understanding the January Effect

To correctly understand this phenomenon, it is necessary to examine December’s stock rout more closely. The majority of market watchers have ascribed these losses to President Trump’s tweets and his protectionist trade policies. However, one factor that has been largely ignored is tax selling.

According to DataTrek Research co-founder Nicholas Colas, this tax fueled sell-off will lead to a rebound in January. This is because when fund managers are facing falling stock prices, they don’t just sell winners to reap profits. Some losers are also sold to offset the increase in tax liability caused by capital gains.

Colas thinks this sort of tax selling did occur in December. The sales proceeds are now being reinvested in equity markets, leading to gains in January. According to Matrixtrade.com’s Ed Matts, the S&P 500 has gained 1.8% on average in January since 1950. This is substantially better than the average increase of 0.7% recorded for other months.

Can Positives Outweigh Negatives This Month?

There is some evidence to show that the influence of this effect has declined since it was discovered in 1976. At the same time, a good January for stocks has a strong correlation with strong annual performance in the months to follow. Matts puts its correlation coefficient at 0.25, which is significantly strong, while it is only 0.016 for other months.

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