The January effect, whereby stocks rally in the first month of the year in an apparent reversal of the tax-loss selling in December, is a well-known phenomenon, but it’s more pronounced for smaller-cap stocks, particularly those that performed poorly in the previous year.
Yet some research indicates that higher transaction costs, including lower trading volumes and wider bid-ask spreads in the weakest-performing small caps, make it difficult to profit from the January effect.
Eric Solver and Barry Knapp, equity strategists at Barclays, took a closer look at this phenomenon between 1986 and 2012.
They identified that the 5% worst-performing U.S. small caps as a group produced stronger returns (roughly 120 basis points) than the Russell 2000 index over both the full sample period and the past 10 years.
As a result, the strategists told clients to be cautious about maintaining short positions in stocks that might benefit from this seasonal trend.