Portfolio Positioning: Will 2023 See the January Effect?

The January Effect is considered a calendar anomaly that may benefit advisers positioning their clients’ portfolios in the new year.

The January Effect is a phenomenon that has long captured the attention of investors, with some hoping to capitalize on it as a way to boost their portfolios in the new year. With 2023 upon us, the question that may be on many advisers' minds is whether the January Effect will be a game-changer for their clients’ portfolios.

What is the January Effect and How it Works

The January Effect refers to the belief in the tendency for equities in general, and small caps and value stocks in particular, to register stronger than average returns during the month of January. This is thought to be due to a number of factors, including tax-loss selling (the practice of selling off underperforming stocks to offset capital gains and reduce tax liability) and the return of liquidity to the market after the holiday season (the flip side of tax-loss selling).

Poor Performance Often Leads to Good Performance

The January Effect has been observed for decades, and it has been shown to be a reliable predictor of market performance in the past. A year in which the market falls, and in particular, when negative December performance is preceded by negative YTD through November performance, is often followed by a strong January Effect, according to a report from financial services firm Jefferies Group.[i]

Jefferies looked at equity performance dating back to 1926. They looked at years in which equities experienced double-digit declines in the first 11 months of the year and subsequently experienced negative performance in December. More often than not, they found above-average performance in the following January. Such was the case in 2022.

Will the January Effect be a game-changer in 2023?

Equities, as measured by the S&P 500, declined -18.11% during 2022, its worst performance since 2008.[ii] After rallying in October and November, the S&P 500 declined almost 6% during December. While we cannot state categorically, much of this selling may have been due to tax-loss selling.

There are a number of factors that can influence market performance in any given year, however, current conditions may point to the possibility of a January Effect. It's worth keeping an eye on small-cap and value stocks in January and considering whether the January Effect might be a worthwhile strategy for your clients’ investment portfolios.

Ways to Position Your Client’s Portfolio for a January Effect

• Small-cap stocks may be an obvious target as smaller stocks have historically been beneficiaries of the January Effect according to Jeffries.
• Looking at investment styles, the S&P 500 Value outperformed the S&P Growth Index by over 24 percentage points, one of its widest disparities in history.
• Factors such as growth and high beta underperformed defensive factors such as low volatility and dividend yield, and therefore, may be a beneficiary of a January Effect.
• Another area that may benefit from a January Effect is thematics which struggled during 2022. Many thematics focusing on disruptive technology suffered during 2022. These may be poised to benefit if the market experiences a January Effect.

It's important to note that the January Effect is not a sure thing, and it's possible for small-cap and value stocks to underperform in January or for the market as a whole to have a poor showing. As with any investment, it's important to do your research and make informed decisions based on your own financial goals and risk tolerance. ETC offers a suite of ETFs which may benefit from the January Effect if 2023 sees one.
 

View ETC’s lineup that features funds in such disruptive thematics as metaverse technology, medical technology, cryptocurrency and blockchain technology and services, e-commerce, robotics, clean energy, and more – to position your clients’ portfolios for a possible January Effect.

[i] JEF SMID-Cap Themes – A Real January Effect Could Be in the Cards, Jefferies Group, 12/16/22

[ii] Source: Unless otherwise noted, all data sourced from: S&P Dow Jones Indices