2021 has rightfully earned its place as one of the best years for the global stock market. And following a mind-blowing run, Wall Street continues to ride on what could be the largest and longest bull market in the history of bull markets.
Stocks crushed all forecasts to climb to fresh all-time highs, thanks to Covid-driven uncertainty, as low interest rates and trillions in stimulus supported the economic recovery.
December’s Santa Claus rally came with even more year-end gifts for investors. By the end of the month, the S&P 500 had jumped by 27%, Nasdaq closed 22% higher and the Dow advanced by 19%, providing substantial returns despite being some of the safest investment vehicles.
As far as the near term is concerned, the stock market is now anticipating yet another potential rally, thanks to the January effect, which tends to lift stocks amid renewed optimism and a positive outlook for the new year.
So, in light of the phenomenal performance of the stock market in 2021, should market participants expect the January effect to extend the positive momentum and boost stocks in the first few days of 2022?
In short, the January effect is a seasonal rally in stock prices that takes place in the beginning of January.
As already mentioned, the stock market tends to rise in January thanks to year-end optimism. Another factor that may support the theory of the January effect is the influx of new positions, especially in small cap stocks.
Investors and CEOs tend to cash out before the end of the year to avoid paying capital gains tax on their winning trades and then allocate their portfolio to weaker performers with higher upside potential.
This profit taking may lead to dip opportunities for investors who can now enter the market by buying the heavily discounted stocks.
And with interest rate hikes looming on the horizon, it would make sense to take profit now before it’s taken by the tax man instead.
However, it’s important to note that while the January effect is ostensibly a real phenomenon, 2021 has been an unprecedented year for the stock market, and this effect’s impact may be mild or completely subdued.
Any significant movement in the US stock market will undoubtedly influence the direction of other markets, especially if the movement occurs during the US trading session when other markets are still closed.
Looking at the performance of major US indices in January during the past five years, the January effect seems to occur rather consistently, even though sometimes the timing may be off.
In 2017, the Nasdaq index and the S&P 500 gained 3.2% and 0.7% respectively by 23 January. Next year’s gains were even more pronounced as Nasdaq climbed by 5.5% while the S&P 500 rose by 4.7% before starting to decline on 22 January, 2018. The January effect theory rings true for the next three years as well with both indices enjoying gains upwards of 2% by mid-January in 2019, 2020, and 2021.
Based on the aforementioned historical data and the recent performance of the US stock market, the January effect will more than likely take place in 2021 as well.
Another indicator is the recent Santa Claus rally, which tends to precede the January effect.
It’s important to note that while the historical data suggests a bullish theme, even if the January effect does take place this year, it may be short-lived. The majority of the headlines will focus on the Fed and any pandemic developments that may affect the market climate overall.
However, it would be interesting to see how smaller stocks perform during this period as investors seek out potential outperformers.