Is the January stock market effect real?

The January effect is based on the idea that January tends to be a good month for stock markets. It goes back as far as the early 1940s to investment banker Sidney Wachtel. He was the first person to suggest that American stock prices go up more in the opening weeks of the year than in any other month.

Later research looked to confirm this seasonal investment theory and said that this especially affected smaller-cap companies.

A lot of investors have had a great start to 2024 with global stock markets soaring.

US markets hit an all-time high after a strong month for US-listed companies. Netflix had impressive quarterly results and Microsoft became the world’s most valuable company with a market capitalisation of more than $3tn.

As always though, remember, past performance isn’t a guide to the future.

So, is this proof that markets rise sharply in the first month of the year or is it a myth that doesn’t stand up to scrutiny?

Is there evidence of a January effect?

Schroders looked at 130 years of data and found that January does tend to be a good month for investors.

Its research, going up to the end of January 2020 – just a few weeks before the first COVID-19 lockdowns – showed the US stock market rising 85 times out of 130.

Schroders also found figures were higher in other markets. January was a positive month 78% of the time in Australia, 74% in Japan, and 71% in the UK.

Of course, you can read pretty much anything into a set of data – and there are plenty of Januarys where stock markets have struggled. For example, some UK markets have gone through a lacklustre start to 2024 as sticky inflation has made it less likely that the Bank of England will cut interest rates earlier.

This article isn’t personal advice. If you’re not sure whether a course of action is right for you, ask for financial advice.

Why are markets better in January?

There are a few theories as to why markets are often stronger in January.

One of the most common is investors selling loss-making shares to offset gains elsewhere and lower capital gains tax liabilities. They then buy them back in January, pushing up the prices.

Other ideas include people putting Christmas bonuses to use in the stock market.

Optimistic investors starting the new year with a rush of enthusiasm is another potential reason. It could also be possible that the January effect has become a self-fulfilling prophecy.

But the big question is how should investors react? What will happen to stocks heading into February? Are there certain stocks and sectors that should be bought each December?

The reality is that such short-term strategies are rarely a good idea. Investing should be for the long term, in assets that are likely to deliver growth over longer periods (at least five years).

The best course of action is focusing on your investment objectives and base buying decisions on your attitude to risk and the fundamental qualities of the assets chosen.

Rob Griffin is the Managing Director of Senlac Communications. Hargreaves Lansdown may not share the views of the author.