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George Anang writes: Understanding the ‘January Effect’

George Anang writes: Understanding the ‘January Effect’

For salaried workers, the month of January is symbolic of very prudent spending, following the lavish spending that comes with December’s festive season. The ripple effect of the over prudent spending habits in January have tagged the month as the longest waiting period for a salaried worker in receiving the next paycheck.

The month of January, in relation to Ghana’s weather, is also noted for the extremely dry and dusty north-eastern winds that emanate from the Sahara Desert and blows over West Africa into the Gulf of Guinea. This weather is known as the “Harmattan”. The adverse effect of the Harmattan weather on the natives has led to the twi (a popular Ghanaian local dialect) name for harmattan “Op3pon”. Op3 meaning dry and Pon meaning supreme, translating into the supreme dry weather.

The January Effect

In the field of finance, January is also noted for a phenomenon known as the “January Effect”. This describes the calendar effect, where there is a seasonal increase in the prices of stocks. Observing this phenomenon in the prices of stocks to a large extent depends on each stock’s capitalisation (total currency value of shares held by individuals and institutions in each stock).

This seasonal increase is more pronounced in small-cap stocks (approximately $300million to $2billion) due to the illiquidity associated with them, than in mid-cap stocks (approximately above $2billion to $10billion) or large-cap stocks (approximately above $10billion). At a high-level, this seasonal increase in price emanates from increases in buying pressure in January following a drop in prices that happens in December. This confirms the basic assertion of microeconomics “The higher the demand, the higher the prices”, all things being equal.

Evidence of the January Effect.

Research dates the discovery of this seasonal effect to as far back as 1942 and is attributed to investment banker, Sidney B Wachtel. He observed that since 1925 small-cap stocks outperformed the other stock categories, with most of the disparities occurring before the middle of the month.

Additionally, in a study conducted by Investment firm, Salomon Smith Barney, data analysed from 1927 to 2002 (75-years) showed that stocks of Russell 2000 index (small-cap stocks) outperformed stocks in the Russell 1000 index (large-cap stocks) by 0.82% in the month of January. Other researchers have also found evidence of the existence of the January effect. Finally, in 1928 through to 2018, the S&P 500 rose 56-times out of 91-times, representing 62% of the period.

Causes of the December drop in price of stocks

Given that the January-rise in stock prices emanates from the December-drop in prices, it is prudent to understand what causes the drop in stock prices for December. A number of economic as well as psychological explanations help explain the January effect.

First and foremost, is the idea of tax-motivated trades by investors. This explanation asserts that investors sell poor performing stocks (losers) at the end of the year in order to realise capital losses which can be used to offset capital gains elsewhere in the following year. The sell-off pressure in December results in low prices for stocks, which eventually picked up in January, leading to the observed rise in stock prices.

Secondly, the end of the year comes with bonuses for most individual investors. Investors, therefore, tend to spend during the festive season, with room to spare to purchase investments in January.

Another reason is the effect of window dressing by fund portfolio managers. With fund managers preparing end of year accounts for investors, there is a high tendency to sell losing stocks at the end of the year in order for reports to show profitable stocks. Portfolio managers subsequently invest in lesser-known small-cap stocks (riskier stocks) in January, with the hope of making a profit going forward.

The final reason is one most Ghanaian investors identify with. The month of January comes with a lot of resolutions; with savings and investments usually being a major part of individual resolutions.

Most individuals, therefore, have the investment psychology that January is the ideal month to begin an investment program. This willingness and ability to invest at the beginning of the year leads to increase demand for investment securities such as stocks. With the increase in demand for stocks come the increase in prices of stocks.

The Dwindling Effect of the January Effect

Albeit the reasons given to justify the relevance of the January effect, there is growing evidence from both academic literature and professional practice that suggest the dwindling effect of the January Effect.

A major position of critics of the January Effect is that given the phenomenon was first identified in 1942, many investors deliberately look forward to making profit from this effect in January. In other words, the January effect becomes priced into the market, nullifying it all together. This makes it impossible for anyone to effectively make any profit from the January Effect. In simple terms, the nett effect of everyone knowing the secret to making abnormal profit is that no one gets to make any profits at all.
Case of Ghana and the January Effect.

To present a case of the January Effect in Ghana, it would be prudent to obtain data from the Ghana Stock Exchange Composite Index (GSE-CI) and run a robust regression to prove or disprove its existence in Ghana’s stock market. However, for the purposes of easy understanding, figure 1.0 below shows the monthly data over a 5-year period (2015-2019) depicting the price movements of the stock market in the period of January.

With 5-data points highlighted in the graph, only 3-points (2016, 2017 and 2020) showcase the January effect. That leaves 2018 and 2019 showing contrary movements to that of the January effect.

One reason that may account for this is that the returns recorded here from the Ghana Stock Exchange Composite Index represent all stocks (small, mid and large-cap stocks).

This would, therefore, make it difficult to clearly observe the January Effect as it is more pronounced in small-cap stocks. However, as mentioned earlier, a better reflection and proof of the January Effect in the GSE-CI would be to run a robust regression with economic interpretations that validate the results.

Keeping January in Mind

Going forward, expectations of the end of month pay-check or the prevalent weather conditions should not be the only reasons we tag the month of January with. The period’s effect on stock price movements is also an interesting highlight to take note of.

References

Haug, M., & Hirschey, M. (2006). The January Effect: Still there after all these years. Financial Analyst Journal, 52(1), 78-88.
Reinganum, M. S. (1983). The Anomalous stock market behaviour of small firms in January: empirical tests for tax-loss selling effects. Journal of Financial Economics, 12(1), 89-104.
Wachtel, B. S. (1942). Certain Observations on Seasonal Movements in Stock Prices. The Journal of Business of the University of Chicago, 15(2), 184-193.
(2020, January 19). Retrieved from Wikipedia: https://en.wikipedia.org/wiki/Harmattan

 

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The writer, George Ephraim Afotey Anang, FMVA is a Financial Analyst with top-notch experience in Financial Analysis, Investment Banking, Financial Advisory and Business Valuation. He holds a BSc in Banking and Finance, an MPhil in Finance, a Financial Modelling and Valuation Analyst Certification and is currently a CFA level 2 Candidate. For any comments to this article, kindly email [email protected]

Source: George Ephraim Afotey Anang

Source: citifmonline.com

Original Story on: Citi Newsroom
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