“Can you profit from the January effect in the stock market?” asks a headline of a leading business magazine from a few years ago. If a reader comes across such an article, they will quickly get the context. Research shows that at least in the US, January tends to be one of the best months for stock markets.
This phenomenon, called the January effect, was first noted as far back as 1942 and was confirmed by additional research later.
According to one study, since 1900, the average monthly return of the S&P 500 in January is the highest among all months at 1.57%.
Reasons behind the January effect
Analysts say there are many reasons behind the existence of January effect.
A key reason is said to be tax-loss harvesting, which is conducted in December (the last month of the financial year in the US). Here investors sell both lossmaking and profitable stocks to set off their losses against gains. The stocks are then bought back in January, leading to generally more buoyant prices.
Other reasons are more buying of stocks in January resulting from year-end bonus payouts or “window dressing” by mutual fund managers.
The effect is even more pronounced when it comes to small-cap stocks, ostensibly because they tend to be less liquid and hence more sensitive to any significant additional buying.
Should you buy stocks in the run-up to January?
So as the clock winds down on 2023, should you go out and load up your demat account with a bunch of stocks? The answer: not so quick.
First, the January effect has started waning even in countries where it used to be fairly evident. According to analysis by Investopedia, since 1993, there have been only 17 positive January months out of 30, compared to 13 negative, meaning the chance of the market posting a gain is only marginally better than the flip of a coin.
Second, and this is important, the phenomenon doesn’t exist at all in India. If anything, the opposite is true.
The January effect in India (or lack thereof)
According to data compiled by Capital Mind, between 2000 and 2023, the NIFTY50 has given a median return of -0.6% in January, having posted a loss in 14 out of 24 months.
This makes January the worst-performing of all months, with November being the best with a median monthly return of 3.8%.
January is also the worst month for the NIFTY Next 50, with a median return of -2.6%. The best-performing are July and April, with average gains of 4.6% and 4.5%, respectively.
Why the January effect doesn’t exist in India
There are a few possible explanations for the absence of, or rather inversion of the January effect. Though in the absence of rigorous studies, they may best be considered conjectures.
First, any impact of tax loss harvesting resulting in stock gains will not lead to the January effect in India, as we follow the April-March accounting year.
Second, the phenomenon is not well-known in India, which means it is unlikely to become a self-fulfilling prophecy.
A self-fulfilling prophecy is a common bias in the stock market, most often seen in technical analysis where, for instance, if enough people believe that a stock will fall rapidly if it breaks a crucial resistance level, the belief will cause them to sell when it breaks that level, thereby bringing about the fall.
There may also be a few more reasons for the lack of the January phenomenon but that is not the point of this piece. The question is should you really buy stocks now as we approach the year end.
The case for buying now
As plenty of investing literature shows, any time is a good time to buy stocks, provided one does so sensibly.
What does this mean?
There is plenty of evidence to show despite the increase in interest around the market, stock investing remains a habit of only a few.
It is true that a lot of investors have taken to investing through the monthly systematic investment plan (SIP) route, thanks to a phenomenal effort put in by the mutual fund industry and have benefited immensely.
But recent data suggests there are about 13 crore demat accounts in India, which is less than a tenth of the country’s population.
This is even though Indian equities tend to be highly coveted by investors globally, thanks to the country’s growth prospects. Several experts believe India will be the fastest-growing major economy in the world for the next several years, if not decades.
And yet, Indian indices continue to trade at reasonable valuations as seen by ratios such as price-to-earnings or price-to-book.
Data shows that only 17% of households invest in the Indian stock market.
Which means that for the rest 83%, the year-end is a good reminder that they need to start now. Think of it as a new year resolution to start a good habit.
A prudent strategy could be putting down a sum you will not need for the next five years in a low-cost index ETF and keep doing it at the end of every year for the rest of your life.
So, to answer the question posed in the headline: should you buy stocks now, here’s the answer:
- To make a quick buck? No
- If you are a regular investor? No
- If you have never invested and can commit to making it a regular habit? Yes