We want to wish everybody a Happy Holiday season! In this article, we discuss an end of year phenomenon in the stock market known as the January Effect. This is part of the whole concept of tax selling. Some people now use tax bounces at the end of October, after Institutional tax selling is over. At The FRED Report, we use the classic form of this, which is why it is called the January Effect. The idea is good companies are sold down in a sort of “baby with the bathwater” effect, and then rebound in January. So, we do a tax bounce list every year where we buy depressed stocks at the end of December and sell them at the end of January.
We have been asked which method is better. Obviously, we believe our method – buying at the end of December, is better. This is because the “October” methodology does not have a logical end point where the stocks are sold. That method is looking for good fundamental values, but nobody has every explained why, if the stocks being sold are so valuable, they are down in the first place. What big change happens between the last trading day of October and the beginning of November? With the “January Effect” method stocks are down as they are being sold due to of the end of the tax year, and history has shown that the majority of a price rebound happens in the first three to four weeks – which is why we sell everything on the list on the last trading day of January.
There are some additional things to know about the tax selling phenomenon. The first is that, in bull markets, you want to look for names that start making new lows at the end of October and through the end of December, as good companies within that list have the propensity to bounce in the new year. In bear markets, as we have now, stocks with bottoming formations after big declines that have lagged a rally are all candidates. A current, but classic, example of this type of stock is TSLA. That is one of the names on our list, and there are nine more names as well. The second is that this strategy works in both bear and bull markets, but has the most success in a transition from bear to bull.
