From 1996 through 2008, Ned Davis Research (NDR) reports that a portfolio of “January Effect” stocks (a screen of the smallest stocks with the largest price declines in the S&P 500, the MidCap 400, and the SmallCap 600) has produced an average gain of +8.6% from mid-December through the end of January.
This easily exceeds the S&P 500’s average gain of +1.5% during the same time period.
The primary reasons behind the “January Effect” are tax-loss selling and “window dressing” – or perhaps more appropriately in this case, “window undressing.”
During the early part of December, institutional investors tend to harvest tax losses from their losing stocks in order to offset some of their gains (always a good idea).
But in addition, portfolio managers like to try and look smart at the end of the year. So many managers make a habit of dumping out their worst-performing stocks in order to ensure that these losers don’t show up on year-end statements.
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