The outperformance of stocks in January has been linked to the divestiture of assets that have performed poorly and year-end tax-loss selling, but investors may face a different market in 2017.
Equities have often outperformed in January with investors utilizing their year-end bonuses and the proceeds from the sales of their underperforming stocks.
"The well-known 'January effect' refers to the stocks' superior returns during January," said K.C. Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla. "Both retail and institutional investors tend to realize the capital loss of the losers to offset the realize capital gain of the winners."
The higher returns in January can be attributed to the lower stock prices in December stock prices as well, which is why the 'January effect' is also referred as the 'December effect,' he said.
The January effect is more pronounced for small cap and value stocks, which are often the loss leaders. Over the time, this phenomenon has weakened. The January returns of the Russell 2000 have traditionally exceeded 2.5 times compared to the other months, but during the past decade, January's return has been at par with other months, Ma said.
For the 15 years when December's return fell by an average of 4%, the following January staged a rally of 2.2%. During the 15 years when December's return rose by an average of 4.85%, it was followed by flat January returns of 0.40%, he said.
Election years have also affected January's returns. During the past seven presidential elections, four of the seven January returns fell by an average 6% while the other three positive January returns averaged a tiny gain of 0.50%.