vious year and should not be subject to tax-loss selling still rise in Janu-
ary, although not by as much as stocks that have fallen the previous year.
There are other potential explanations for the January Effect. Work-
ers often receive extra income, such as from bonuses and other forms of
compensation, at year-end. These individuals often invest their cash in
stocks in the first week of January. Data show that there is a sharp in-
crease in the ratio of public buy orders to public sell orders around the
turn of the year. Since the public holds a large fraction of small stocks,
this could be an important clue to understanding the January Effect.^6
Although all these explanations appear quite reasonable, none jibes
with what is called an “efficient capital market.” If money managers
know that small stocks will surge in January, these stocks should be
bought well before New Year’s Day to capture these spectacular returns.
That would cause the price of small stocks to rise in December, which
would prompt other managers to buy them in November, and so on. In
the process of acting on the January Effect, the price of stocks would be
smoothed out over the year and the phenomenon would disappear.
Of course, to eliminate the January Effect, money managers and in-
vestors with significant capital must know of the effect and feel com-
fortable about acting on it. Those in a fiduciary position might feel
uneasy justifying what appears to be a very unusual investment strategy
to their clients, especially if it does not work out. Others might be reluc-
tant to take advantage of a phenomenon that seems to have no clear eco-
nomic rationale.
The January Effect Weakened in Recent Years
Perhaps all the publicity about the January Effect has motivated traders
to take advantage of this calendar anomaly since the effect has been far
weaker since 1990 than before. From 1990 through January 2007, the av-
erage January return on the Russell 2000 Index has been 1.36 percent,
only slightly more than the 0.70 percent return on the S&P 500 Index.
Furthermore, the return on the Russell 2000 on the last trading day of
December and the first trading day of January, which had previously
been so high, has been no higher than the S&P 500 Index, and both have
been approximately zero. Finally, the excess return on small stocks dur-
ing the first seven trading days in January, which had been so large be-
fore 1990, has also vanished.
310 PART 4 Stock Fluctuations in the Short Run
(^6) Jay Ritter, “The Buying and Selling Behavior of Individual Investors at the End of the Year,” Jour-
nal of Finance, vol. 43 (1988), pp. 701–717.