Also shown in Figure 18-1 is that if the large January small stock re-
turns persist in the future, it could lead to some astounding investment
results. By buying small stocks at the end of December and transferring
them back to the S&P 500 Index at the end of January, a $1 investment in
this strategy would have grown to $77,891 by the end of 2006 if begun in
December 1925, or a 14.9 percent annual rate of return.
There have been only 16 years since 1925 when large stocks have
outperformed small stocks in January. Furthermore, when small stocks
underperform large stocks, it is usually not by much: the worst under-
performance was 5.1 percent in January 1929. In contrast, since 1925,
small-stock returns have exceeded large-stock returns in January by at
least 5 percent for 28 years, by at least 10 percent for 13 years, and by
over 20 percent for 2 years.
The January Effect also prevailed during the most powerful bear
market in our history. From August 1929 through the summer of 1932,
when small stocks lost over 90 percent of their value, small stocks
posted consecutive January monthly returns of plus 13 percent, 21 per-
cent, and 10 percent in 1930, 1931, and 1932. It is testimony to the power
of the January Effect that investors could have increased their wealth by
50 percent during the greatest stock crash in history by buying small
stocks at the end of December in those three years and selling them at
the end of the following month, putting their money in cash for the rest
of the year!
A fascinating feature of the January Effect is that you do not have to
wait the entire month to see the big returns from small stocks roll in.
Most of the buying in small stocks begins on the last trading day of De-
cember (often in the late afternoon), as some investors pick up the bar-
gain stocks that are dumped by others on New Year’s Eve. Strong gains
in small stocks continue on the first trading day of January and with de-
clining force through the first week of trading. On the basis of research
published in 1989, on the first trading day of January alone, small stocks
earn nearly 4 percentage points more than large stocks.^3 By the middle of
the month, the January Effect is largely exhausted.
When any anomaly such as the January Effect is found, it is impor-
tant to examine its international reach. When researchers turned to for-
eign markets, they found that the January Effect was not just a U.S.
phenomenon. In Japan, the world’s second-largest capital market, the
excess returns on small stocks in January come to 7.2 percent per year,
308 PART 4 Stock Fluctuations in the Short Run
(^3) Robert Haugen and Josef Lakonishok, The Incredible January Effect, Homewood, Ill.: Dow Jones-
Irwin, 1989, p. 47.