Finally, and perhaps most importantly, this year there is the added noise of fiscal cliff negotiations and uncertainty around what the tax landscape will look like in 2013. Currently, without any action from Congress, the rate on both long-term and short-term capital gains could increase next year. This is likely to confound December’s traditional tax-loss-selling story. As Russ has highlighted, investors who anticipate a capital gains tax increase may have an incentive to sell securities that have gains — even if that generates a larger tax bill this year — in order to avoid a potentially larger bill next year. In other words, the “traditional” December focus of tax trading on poor-performing securities may be obscured by additional tax-related trading on securities that have performed well. The data record does not contain obvious comparable cases in the last 20 years to analyze that aspect of story but it is likely to have an impact on the January effect.
In the end, each individual investor should consider their particular tax situation carefully. But insofar as broad portfolio positioning is concerned, sticking to the fundamentals is likely better than the hard squinting that is needed to read the statistical tea-leaves on the potential for a January effect. We continue to advocate a generally defensive position, including with dividends and a well-diversified allocation to international equities.
Daniel Morillo, PhD, is the iShares Head of Investment Research.
[1] See, for example, “Yes, Wall Street, there is January effect! Evidence from laboratory auctions”. Anderson, Gerlach and diTraglia.
[2] Data is sourced from Bloomberg, obtained for each of the sectors as total return index. Monthly returns are computed from the index data and averaged across the last 20-years of data.