Whenever January rolls around, some pundit will invariably mention the "January Effect." The January Effect is a stock market anomaly in which stocks perform better in January than in any other month.

But do they?

Some describe the January Effect as a rally that occurs when investors sell off their investments in December for tax purposes and then buy them back in January. Never mind that wash sale rules prohibit investors from selling a stock and buying it back within the next 30 days for such a purpose -- or that the proliferation of tax-sheltered retirement plans makes it largely unnecessary to do so.

Others note that the January Effect is more pronounced in small-cap stocks than in large caps because of their higher concentration among individual investors. Let's see if that's true. To test these two phenomenons, I did a simple analysis of two indexes, the S&P 500 (SNPINDEX:^GSPC) and the Russell 2000 (RUSSELLINDICES:^RUT), which represent large caps and small caps, respectively, to see whether:

  1. January really does see the best performance
  2. Small caps really do outperform large caps in January

I looked at the average performance of each index by month since October 1987, which is the earliest point for which Yahoo! Finance provides data on the Russell 2000. What I found may surprise you:

Month

S&P 500

Russell 2000

January

0.7%

0.9%

February

0%

1.1%

March

1.3%

1.6%

April

1.8%

1.6%

May

1.1%

1.3%

June

(0.4%)

0.1%

July

1%

(0.3%)

August

(1%)

(0.7%)

September

(0.2%)

0.3%

October

0.5%

(1.2%)

November

0.9%

1.1%

December

2.1%

3.5%

January's performance is not even in the top half! What about the impact of small-cap stocks? The performance of small caps is roughly 20 basis points higher on average, but considering the Russell outperformed the S&P 500 by roughly 150 basis points overall, I wouldn't attribute that outperformance to the January Effect. I'm no statistician, but I'd wager that's probably within the margin of error.

The best-performing month is actually December.

Santa Claus Rally: 1
January Effect: 0

If you guessed correctly, then pat yourself on the back. Now I understand Burton Malkiel's take on the the January effect: "Wall Street traders now joke that the "January effect" is more likely to occur on the previous Thanksgiving."

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