New Year Effect. Does it exist?

Vladimir Daragan, STTA Consulting Inc.

There is a popular opinion that stock price moves during the last trading days of a year and during the first trading days of a new year are highly predictable. It is related to the tax problem and "window dressing" effect.

Before December 31
Individual investors sell their losers by December 31 to get tax return. Institutions are also selling losing stocks to improve their portfolios ("window dressing"). On the other hand institution are buying winners for the same reason, that compensates effect of falling index price.

After January 1
Institutions heavily buy stocks after New Year to build a new portfolio. Many individual investors start buying stocks after New Year too. It looks like everyone wants to start a new life after a New Year event.

Therefore, one can expect falling stock prices during the last days of December and rising prices after a New Year event. One can expect some correlation of this effect with performance of the market during the previous year. To check this hypothesis we performed statistical analysis of 101 year history of the Dow Jonew Industrial Average. The results are shown on the figure.

One can see that stocks price are not falling during the last days of December.  The only significant effect is rising stock prices during the first trading day of a year. It was a surprise for us that before New Year the average index prices are also rising.

However the standard deviations (showed as vertical bars) of price changes are rather large to rely on this observation for short-term profit.