Testing the January effect

An investigation by Daily Investor shows that January is generally a strong month for the JSE All Share index, but it is not the best performer.

The January effect is a theory that January is the strongest month for investors as the stock markets tend to boom in the first month of the year.

This phenomenon was first noted in 1942 by Sidney Wachtel – an investment banker – and has been the topic of many debates and research papers.

Many believe tax planning practices cause the January effect. The theory is that investors sell their loss-making stocks in December to offset their capital gains to pay fewer taxes.

Therefore, the stock market should see a poor December month due to excessive selling practices.

Once the year ends, investors are believed to repurchase these same stocks in the hope of generating profits from them in the following year.

The large-scale repurchasing in January is thought to boost January stock returns.

Many have pointed to this as a way to disprove efficient markets and a strategy to generate alpha – higher returns than the market.

The January effect is hotly debated, and there is no consensus on the topic.

Many analysts argue that the widespread knowledge of the January effect causes investors to buy stocks in December in anticipation of the January rally, thereby eliminating its dynamics.

This theory seems to have been supported by most data, as many researchers noted that the observed January effect became less pronounced over the years.

Others say the current January effect is so subtle that the transaction costs on the trades from December to January would eliminate any abnormal returns deeming it worthless.

Daily Investor performed two sets of analyses to test the validity of the January effect.

  • We tracked the JSE All Share index from 1995 to determine if there was a month that delivered better average returns. We also checked whether January stood out as the best performer and whether there was a selloff in December.
  • We investigated two investment strategies – the first is to take R100 and invest it in the JSE All share index at the beginning of each January and disinvest after one month from 1995 to 2022. We repeated this strategy for December.

The results are described below.

JSE All Share index monthly performance from 1995

Our analysis showed that the market performed the best in December, with an average monthly return of 3.9%. It was, therefore, contrary to the theory.

January performed well but did not stand out as much as the theory suggests, as it ranked fourth behind December, October, and April.

Month Average Return Month High to Low
Jan 2.10% Dec 3.89%
Feb 0.23% Oct 3.08%
Mar 0.07% Apr 2.88%
Apr 2.88% Jan 2.10%
May 0.32% Jul 1.16%
Jun -1.08% Nov 1.11%
Jul 1.16% May 0.32%
Aug 0.07% Feb 0.23%
Sep -0.92% Aug 0.07%
Oct 3.08% Mar 0.07%
Nov 1.11% Sep -0.92%
Dec 3.89% Jun -1.08%

Investing in December and January

Investing in December and selling shares at the end of the month performed much better than doing the same in January.

December delivered a return of R193, significantly higher than the January strategy with R129.

These simple analyses suggest that for the past 27 years, there was no overwhelming evidence for the January effect on the JSE All Share index.

A potential reason why the January effect is not seen on the JSE is because of the February tax year-end as opposed to the US December tax year-end.

One would then expect February to have low returns followed by a strong March performance on the JSE.

This is not substantiated by the data as February was the eighth-best performing month at an average 0.23% return, which may support the tax selloff theory.

However, March lagged the average February return at an average return of 0.07% not showing any support of a March boom.

This article was first published by Daily Investor and is republished with permission.

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Testing the January effect