The stock market is quite dynamic and filled with numerous concepts, some of which can surprise you! Once such a concept is market anomalies. Market anomaly refers to skew/abnormal returns which creates a question on the Efficient Market Hypothesis (EMH). EMH, in simple words, means that stock prices reflect every single piece of information and news available at all times and can generate market-beating returns.
While this concept is fascinating, it is not intimidating as not all market anomalies have severe outcomes and impact on your portfolio. The degree of impact, if any, also varies based on the existing market condition.
While we are on the verge of welcoming 2023, it is the perfect time to discuss one of the most popular market anomalies called the January Effect and whether or not it has any impact on your portfolio returns.
What is the January effect?
The January Effect suggests that in the month of January the stock prices witness higher mean returns than in the other months of the year. This anomaly can be traced back to 1942 when it was first observed by Sidney Wachtel. He found that stock returns from 1925 onwards reported higher prices in January than in other months of the year.
According to the cohort who support this school of thought, they believe that this hypothesized market anomaly could be a result of end-of-the-year tax-loss harvesting when investors sell off their low-performing stocks at the end of the year.
Since stocks sold at the end of the year at losses would be available at the beginning of the next year at a bargain, investors would be prompted to buy them. This increases the demand for those stocks and increases prices during January.
Other hypothesised reasons are associated with investors putting any year-end cash bonuses into the market, and investor psychology. Investors might be inclined to start their investment journeys at the beginning of a new year, possibly as a new year’s resolution.
Does January Effect have any influence on your portfolio returns?
We found through Nifty 50 returns over the past 22 years that, had an investor who invested in top Indian stocks at the beginning of the year and held for 5 years versus an investor who invested in the same stocks in February and held for 5 years, would ultimately see no difference in the performance of their stocks. See the graph below.
The graph above plots the 5 year returns of investments held from January 1st of every year for a duration of five years, which we have named “Year till January Returns” versus the 5 year returns of investments held from February 1st of every year for a duration of five years, named “Year till February Returns”.
We do this to isolate the “January Effect” if it does in fact exist. We find that the returns are more or less identical.
From a statistical standpoint, the returns have a correlation coefficient of 0.99, which means that the January returns are highly correlated with the February returns. A high correlation between the two returns indicates that the January Effect remains only a perceived market anomaly.
Like the January Effect, there are many other market anomalies such as the September Effect (historic market returns are lower in Sep), the Monday Effect (market trend of Friday picks up and prevails on Monday), and so on. However, most of these anomalies are anecdotal and do not hold firm ground.
Based on the analysis, we can conclude that the January Effect in recent years is not a regular phenomenon. There is no real evidence that stock prices increase or decrease regularly at certain times of the year. As far as we know, markets tend to be efficient and stock markets regulate themselves in the long run.
This makes it clear that whether you invest in January or June, if you focus on your long-term financial goals and wealth creation, there is no impact on your investment portfolio of short-term market noise and anomalies.
(By Anup Bansal, Chief Business Officer, Scripbox. Views expressed above are personal)