The ‘January Effect’ could be the market’s big hope for a bounce

Despite Wednesday’s record-breaking rally, U.S. stocks are still on track for their worst December since the Great Depression. While much of the blame has been cast on the Federal Reserve, President Donald Trump’s tweets and the trade war, one overlooked explanation for the bleeding is tax selling.
Although the year-end tax selling intensified December’s stock rout, it will likely yield to a bounce in January, which is the logic behind the Wall Street’s “January effect,” a theory that there is a seasonal rally in stocks during the first month of the year, according to Nicholas Colas, co-founder of DataTrek Research.
“The idea is that beaten up small cap stocks tend to trade higher in January as tax loss selling abates and more normal buy-sell balances reassert themselves,” Colas said in a note to investors.
When money managers get hit by a sharp reversal in stock prices, not only do they sell the winners from early in the year to reap the gains, they also tend to sell some losers to minimize the tax bill from the capital increases — the so-called tax selling, which is very much at play in December, according to Colas.