After enduring a year for the history books , investors in U.S. stocks may get a nice surprise at its tail end.
“Although investor focus is certainly on the election and reporting season, we think we could see an Early January Effect,” wrote Jefferies strategists in a recent note.
The “January effect” refers to the tendency of stocks to return much more in that month than others – an average gain of 1.8% in the first month of the year versus 0.7% in other months , according to a 2019 MarketWatch analysis – as investors sell losing stocks at the end of the year to lock in tax losses, and then buy them back after the calendar turns.
“We think an early January Effect is driven by the fact that investors may be reluctant to sell their winners while in their 2020 fiscal year and generate a large capital gains tax when it has been a tough year,” the Jefferies analysts wrote. “They may be holding onto these gains until their fiscal years roll to 2021 and for many funds, that date is October 31st.”
But, the team notes, the “January” effect has in recent years become a bit more fuzzy, and not just confined to the one month. “With the advent of mutual funds and the moving up of their tax year-end, the January Effect has come into play earlier,” they explained.
If their thesis holds, it could mean some underperformers – particularly small-capitalization stocks – catch a second wind. Over the past 34 years, the Jefferies’ analysis finds, small-caps usually beat large-caps over the upcoming three months, by an average of 90 basis points. That margin widens when small has lagged large in the first 10 months of the year, as has been the case in 2020.
“We also looked at the last 8 elections and small tends to bounce sharply over next three months when this event is behind us,” they wrote.
It is worth noting that small-caps, as measured by the Russell 2000 /zigman2/quotes/210598147/delayed RUT +0.56% index, have recently started to outperform bigger stocks. The Russell is up more than 9% in the past month, compared to a 3.1% gain for the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.24% , for example.
Many investors have been itching for an opportunity to rotate away from the giants of the market – the Nasdaq Composite /zigman2/quotes/210598365/realtime COMP +0.92% has gained 27% in the year to date – and toward less-pricey options. If the “January” effect morphs into a “late-year” effect, it could be just the right time for it.