Fundamental analysis – The January Effect

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January effect

The January effect refers to investors’ belief that there is a seasonal anomaly where small capitalization stocks outperform large capitalization stocks in the first month of the year. Research suggests that, while there is indeed a January effect, the size of the effect has been decreasing and it is probably to too small for investors to exploit. Nevertheless, investors’ behavior might help explain the presence the January effect.

Behavioral explanations

The first behavioral explanation is tax loss harvesting. Often, investors’ realised capital gains are taxed. At the same time, these investors can also deduct realised losses. If that’s indeed the that case, then it makes sense for investors to sell positions that have lost money. These realised losses can be subtracted from realised gains. At the start of next year, investors might then buy back the stocks they sold for tax purposes, because they never really intended to actually close down these positions permanently. If these tax-sensitive investors tend to hold smaller capitalization stocks, this buying pressure might drive up prices of these stocks in January, causing the January effect.

A similar effect could be at play in the case of institutional investors. These institutional investors, e.g. fund managers, are often evaluated at the end of the year. Quite often, end-of-year rankings of mutual funds are generated and the portfolio composition is communicated to clients. Of course, it’s always nicer to report a portfolio that consists mostly of winning stocks. Thus, institutional investors tend to sell their losing stocks before the end of the year to make their performance look better. This behavior is called window dressing. These investors too might then repurchase their positions at the start of next year, driving up prices.

January barometer

The January effect is sometimes mixed with the January Barometer effect. The January Barometer effect argues that “As goes January, so goes the year”. As such, a first positive month would indicate a positive year for stock returns. In practice, the January barometer effect is a myth, rather than a reality.

Summary

The January effect is not a behavioral bias itself. However, we discussed at least two potential behavioral explanations that might cause such a pattern to arise around the start of the new year. However, even if a January effect is present, it is probably too small and there’s little use in trying to exploit it.

Investments & Securities Test Bank Questions Chapter 8

Термины в модуле (86)

A. there were no predictable patterns in stock prices

B. stock prices exhibited strong serial autocorrelation

C. day-to-day stock prices followed consistent trends

A. all past information, including security price and volume data

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B. all publicly available information

C. all information, including inside information

A. all security price and volume data

B. all publicly available information

C. all information, including inside information

A. all security price and volume data

B. all publicly available information

C. all information, including inside information

A. irrational markets

B. that prices cannot equal fundamental values

C. that technical analysis to uncover trends can be quite useful

A. early in the month

B. in the middle of the month

C. late in the month

A. short-run; short-run

B. long-run; long-run

C. long-run; short-run

A. a conservative investment strategy

B. a liberal investment strategy

C. a passive investment strategy

A. indicate that prices are useful indicators of true economic value

B. indicate that the market is not incorporating new information into current stock prices

C. ensure that an economy allocates its resources efficiently

B. Relative strength analysis

C. Earnings forecasting

A. Analyzing the Fed’s next interest rate move

B. Relative strength analysis

C. Earnings forecasting

A. well-run firms

B. poorly run firms

C. mispriced stocks

A. about 30 seconds

B. about 10 minutes

A. A normal return

B. A subliminal return

C. An abnormal return

A. fundamental analysis

B. technical analysis

C. index management

A. The magnitude issue

B. The tax-loss selling issue

C. The lucky event issue

A. weak-form efficient

B. semistrong-form efficient

C. strong-form efficient

A. the month of January

B. the month July

C. the trough of the business cycle

A. regulatory effects

B. high trading costs

C. information asymmetry

A. should focus on relative strength

B. should focus on resistance levels

C. should focus on support levels

A. rely on technical analysis to select securities

B. rely on fundamental analysis to select securities

C. use a passive trading strategy such as purchasing an index fund or an ETF

B. market anomaly

C. fundamental approach

A. decreased; decreased

B. decreased; increased

C. increased; decreased

A. had negative alphas before fees were considered.

B. had positive alphas after fees were considered.

C. had negative alphas after fees were considered.

A. the strong-form EMH

B. the weak-form EMH

C. technical analysis

A. positive; positive

B. positive; negative

C. negative; positive

A. earned higher average returns than firms with low P/E ratios

B. earned the same average returns as firms with low P/E ratios

C. earned lower average returns than firms with low P/E ratios

B. neglected stocks

C. stocks that are frequently in the news

I. Low-cost diversification
II. A portfolio with a specified risk level
III. Better risk-adjusted returns than an index

B. I and II only

C. II and III only

A. were higher than the risk-adjusted returns of large firms

B. were the same as the risk-adjusted returns of large firms

C. were lower than the risk-adjusted returns of large firms

A. the markets cannot be allocationally efficient

B. systematic risk does not matter

C. no type of analysis can be used to generate abnormal returns

B. selection bias

B. selection bias

A. designed to test whether inside information can be used to generate abnormal returns

B. based on technical trading rules

C. unable to generate any evidence of market anomalies

I. January
II. neglected
III. liquidity

C. II and III only

I. The small-firm effect
II The book-to-market effect
III The neglected-firm effect
IV. The P/E effect
A. I and II only

B. I and III only

C. II and IV only

A. weak-form efficiency argument

B. semistrong-form efficiency argument

C. strong-form efficiency argument

A. high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a unique risk factor

B. low book-to-market firms are underpriced or the book-to-market ratio is a proxy for a systematic risk factor

C. either high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a systematic risk factor

A. investors cannot usually earn abnormal returns by following inside trades after knowledge of the trades are made public

B. investors can usually earn abnormal returns by following inside trades after knowledge of the trades are made public

C. investors cannot earn abnormal returns by following inside trades before knowledge of the trades are made public

A. stock prices do not rapidly adjust to new information

B. future changes in stock prices cannot be predicted from any information that is publicly available

C. corporate insiders should have no better investment performance than other investors even if allowed to trade freely

A. stock price changes that are random but predictable

B. stock prices that respond slowly to both old and new information

C. stock price changes that are random and unpredictable

I. There are no arbitrage opportunities.
II. Security prices react quickly to new information.
III. Active trading strategies will not consistently outperform passive strategies.

C. I and III only

A. slightly overly optimistic

B. overwhelmingly optimistic

C. slightly overly pessimistic

A. an abnormal price change immediately after the announcement

B. an abnormal price increase before the announcement

C. an abnormal price decrease after the announcement

A. an exogenous shock to the market that is sharp but not persistent

B. a price or volume event that is inconsistent with historical price or volume trends

C. a trading or pricing structure that interferes with efficient buying and selling of securities

A. Over 25% of mutual funds outperform the market on average.

B. Insiders earn abnormal trading profits.

C. Every January, the stock market earns above-normal returns.

A. Intel has consistently generated large profits for years.

B. Prices for stocks before stock splits show, on average, consistently positive abnormal returns.

C. Investors earn abnormal returns months after a firm announces surprise earnings.

A. The average rate of return is significantly greater than zero.

B. The correlation between the market return one week and the return the following week is zero.

C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

A. technical analysis cannot; fundamental analysis can

B. technical analysis can; fundamental analysis can

C. technical analysis can; fundamental analysis cannot

A. high-beta stocks are consistently overpriced

B. low-beta stocks are consistently overpriced

C. nonzero alphas will quickly disappear

A. investing in a well-diversified portfolio without attempting to search out mispriced securities

B. investing in a well-diversified portfolio while only seeking out passively mispriced securities

C. investing an equal dollar amount in index stocks

A. the tenure of the fund manager

I. Value stocks are out of favor with investors.
II. Prices of growth stocks include premiums for overly optimistic growth levels.
III. Value stocks are likely to generate positive-earnings surprises.

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