A January Effect for Large-Cap Stocks?
Thursday, December 13, 2012
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

The January Effect
Tax-selling can create attractive buying opportunities.

Rules for Capital Losses
Wash sale rules restrict you from rebuying a stock too soon.

AAII Discussion Boards
Have you sold stocks for tax reasons?

Most Popular AAII Articles

  1. “The Permanent Portfolio: Using Allocation to Build and Protect Wealth”
  2. “Retirement Withdrawals: Can You Base Them on RMDs?”
  3. “Rules of Thumb and Key Phrases: Gleaning the Nuggets of Truth”


Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 43.2%, up 1.0 points
  Neutral: 26.7%, up 3.5 points
  Bearish: 30.1%, down 4.5 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »


The January effect is the tendency of low price, small-capitalization stocks to outperform in January. Historically, these are stocks that were sold for tax reasons late in the prior calendar year and repurchased the following January because investors still think the stocks are fundamentally attractive. Since individual investors using this strategy must wait 30 days before repurchasing any stock sold at a loss to avoid triggering the wash sale rule, these stocks can decline in December and rise in January. The wash sale prevents a loss from being realized if a substantially identical security is repurchased within 30 days of a sale.

Due to the uncertainty about 2013 tax rates, it is possible that we are seeing some stocks getting set up for a large-cap version of the January effect. In this case, the selling pressure could be coming from investors wanting to realize long-term gains at the known tax rate of 15%, rather than risk a potentially higher tax rate in 2013. Individual investors who sell a stock to realize a capital gain can repurchase the stock immediately and reset their cost basis to a higher level. They must wait 30 days to repurchase the stock, however, if they want the flexibility of writing off a potential loss on the new position.

Market observers don’t get detailed reports on why a stock is being sold. As you know, online discount brokers do not ask you why you’re selling when you place an order to do so. Thus, we rely on a combination of news events, surveys and analysis to identify plausible explanations. For example, there are large-cap stocks with a good 52-week performance, lackluster four-week returns and comparatively attractive valuations. This combination suggests the possibility of capital gains harvesting at known tax rates.

To find these stocks, I created a simple screen in our Stock Investor Pro stock screening program that looks for stocks with four specific characteristics. First, all passing companies had to be members of the S&P 500, thereby limiting the universe to large-cap stocks. Second, passing companies must have had 52-week relative strength rankings of 75% or higher. This restricts the universe of large-cap stocks to only those whose 52-week price gains ranked in the top quartile of all (not just large-cap) stocks. Third, passing stocks were required to have declined in price over the past four weeks, as of December 7, 2012. If tax-related selling is occurring, then the share price should show some recent weakness. (Requiring a four-week relative strength rank of below 50% instead would have identified a few more companies.) Finally, the current price-earnings ratio had to have been below the stock’s five-year average. I included this component to limit the passing companies to those trading at valuation levels below what investors have typically paid.

(For those of you wishing to replicate the strategy, the specific search terms I used in Stock Investor Pro were Company Information: Standard and Poor Stock equals 500; Rank: % Rank-Rel Strength 52-week >= 75; Price and Share Statistics: Price Change 4 week < 0; and Multiples: PE < PE-Average 5 years.)

A list of the passing companies is presented in the table below. Since this is a very basic screen, be sure to do further research before buying any of the stocks. Also, be sure you like the long-term prospects, as there is no guarantee a January effect will lift these stocks. The data may fit the theory, but there is always the risk of the theory not working in reality.

Table 1. Top-performing large-cap stocks that have recently declined in price.

Company Ticker 4-Week Return (%) 52-Week Return (%) Current P/E 5-Year Average P/E
Apple Inc. AAPL -2.52 36.5 12.1 12.7
Capital One Financial Corp. COF -2.23 27.62 9.5 71.7
Franklin Resources, Inc. BEN -0.95 32.34 14.3 15.7
Harris Corporation HRS -0.33 38.35 10 12.5
M&T Bank Corporation MTB -1.46 35.69 15.2 15.4
Quanta Services Inc PWR -0.27 28.94 20.2 28.4
U.S. Bancorp USB -0.25 24.83 11.4 14.9
Williams Companies, Inc. WMB -2.65 22.86 29.5 35.6

*Source: AAII Stock Investor Pro. Data as of December 7, 2012. We currently hold both Apple (AAPL) and U.S. Bancorp (USB) in our Stock Superstars Portfolio.


Tax Guide Update

Given the lack of a resolution to the fiscal cliff, it is probable that we will send the January AAII Journal, which will include our annual tax guide, to the printer with information that will need to be updated. The logistics of publishing a printed publication and the inability of our nation’s leaders to reach a compromise have left us without workable alternatives.

Though the fiscal cliff negotiations primarily impact 2013 tax rates and government spending, there are unresolved 2012 tax issues that are impacted as well. These include, but are not limited to, the alternative minimum tax and the ability to deduct state sales taxes.

We will post an update on AAII when new information is available. If you use other tax guides, such as TurboTax or “J.K. Lasser’s Your Income Tax 2012,” be sure to check for updates. It may make sense to delay filing your taxes until February or March to ensure you are using the most updated information available.

More on AAII.com

The Week Ahead

Investors will get a preliminary look at fourth-quarter earnings next week with 16 members of the S&P 500 reporting. Included in this group are Oracle (ORCL) on Tuesday, Accenture (ACN) and FedEx (FDX) on Wednesday, Discover Financial Services (DFS) and NIKE (NKE) on Thursday and Walgreen Company (WAG) on Friday.

The week’s first economic report will be the December Empire State Manufacturing Survey, released on Monday. Tuesday will feature the National Association of Home Builders’ December housing index. November housing starts and building permits will be released on Wednesday. Thursday will feature November existing home sales data, the December Philadelphia Federal Reserve survey and revised third-quarter GDP. November personal spending and income and the University of Michigan’s final December consumer confidence survey will be published on Friday.

The Treasury Department will auction $35 billion of two-year notes on Monday, $35 billion of five-year notes on Tuesday and $29 billion of seven-year notes on Wednesday.

Richmond Federal Reserve President Jeffrey Lacker will speak on Monday. Dallas Federal Reserve President Richard Fisher will speak on Tuesday.

Friday will be a quadruple witching day, meaning both options and futures contracts will expire.

AAII Sentiment Survey

Bearish sentiment fell to its lowest level since last August, as bullish sentiment increased for the fourth consecutive week, according to the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, increased 1.0 percentage points to 43.2%. This is the highest level of optimism registered by our survey since March 15, 2012. It is also the third consecutive week that bullish sentiment has been above its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 3.5 percentage points to 26.7%. This is a seven-week high. Even with the increase, neutral sentiment is below its historical average of 30.5% for the 11th time in 13 weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, dropped by 4.5 percentage points to 30.1%. This is lowest level of pessimism registered by our survey since August 23, 2012. It is also just the fifth time in the past 36 weeks that bearish sentiment is below its historical average of 30.5%.

The market’s rebound off of its mid-November lows is causing individual investors to be more optimistic about the short-term direction of stock prices. Also playing a role are further signs of economic growth, such as the November jobs report, and seasonality. It should also be pointed out that this week’s readings are fairly close to the historical average, implying that individual investors are neither unusually bullish nor bearish.

This week’s special question asked AAII members what influence the ongoing lack of a resolution to the fiscal cliff is having on their short-term outlook for stock prices. About one-third of respondents said the stalemate was having a negative impact, while another equally sized group said it wasn’t having any impact. Other respondents said the lack of resolution is causing them to be more cautious or that they expected stocks to stay range-bound until a resolution is reached. A few AAII members said they would view any fiscal cliff-related drop in stock prices as a buying opportunity. Several members expressed frustration with the politicians in Washington.

Here is a sampling of the responses:

  • “This [the fiscal cliff negotiations] just adds to the volatility. Long-term investors should just ignore the noise.”
  • “I’m a long-term investor. The so-called fiscal cliff has no impact on my investment decisions.”
  • “Very bearish! It’s unbelievable our elected officials cannot come to some closure on this.”
  • “I will hold off on buying; I believe the market will go down without a satisfactory solution.”
  • “It makes me think the short-term (next month or so) will be volatile for stocks.”
  • “I believe stocks will be down in the short term, but the fiscal cliff will be resolved and the market will go up.”

» Take the sentiment survey