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Santa, January both coming to town?

By Dr. Don Taylor ·
Friday, November 22, 2013
Posted: 12 pm ET

The U.S. stock market is having a great year. As I write this, the Dow Jones industrial average closed above 16,000 for the first time and the Standard & Poor's 500 index moved above 1,800 in daily trading.

Investors are often advised to look at their portfolios and do some "tax-loss harvesting" at year-end and sell the stocks that haven't done well in their portfolio, and potentially pair those losers with stocks where they have taxable gains. I won't go into depth on tax-loss harvesting because a rising tide lifts all boats and my point is that there should be fewer losses to harvest this year.

Instead, I want to talk about the possibility of a Santa Claus rally and the January effect. The Santa Claus rally has traditionally been defined as the trading days after Christmas until the first trading day in the new year, although any upswing in the stock market in December is often mistakenly called a Santa Claus rally by the press.

The explanation for the rally that I find most amusing is that it happens because market pessimists are on vacation that week. Like all the market Scrooges don't wake up Christmas morning with a lighter heart and say bah humbug instead, and took the rest of the year off while market optimists keep going to work and investing in the market.

The January effect is somewhat different -- it's an expectation that has stock prices rising in January. Historically, the argument was that stock prices fell late in the year because of tax-loss selling, and markets went up in January as this money was put back to work, especially the first trading week of the year. Said to be more relevant for small- and mid-capitalization stocks, there's an argument that since many investors hold stocks in tax advantaged retirement funds, there's not the tax-loss pressures at year-end and less buying at the start of the new year. Regardless, this January effect has diminished in importance over the years.

There's a separate school of thought that looks at the first five trading days of January as a method of forecasting what's in store for the U.S. stock market over the remainder of the year. If the stock market is up in the first five trading days of the year, more likely than not, the stock market will be up for the year. Others consider the returns on the whole month for January to be the barometer for the remainder of the year.

Can you believe in both the Santa Claus rally and the January effect(s) or does one preclude the other?

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