New Year Effect and Market Reactions at Quarter and Year End

Predictable and exploitable seasonal stock market price patterns

Market reactions at quarter and year end, such as loss realizations to reduce capital gains tax, are phenomena that can affect investors and traders. Although there is no fundamental reason to change your investment strategy at year end, there may be opportunities to take advantage due to the increased activity and mechanistic reallocations that occur at the turn of the calendar year.

New Year Effect

The New Year Effect means that the high engagement around the New Year creates interesting opportunities for profitable trades on the stock market. Many investors care about the new year, and the increased activity can lead to unmotivated price movements that you can take advantage of.

Mechanistic Reallocations

At quarter ends, especially at the end of the year, a lot of automatic reallocation of capital takes place. This creates effects that you can exploit to make smart trades on the margin.

Dogs of Dow

One strategy that has historically worked well is Dogs of Dow, which involves buying last year’s losers. Stable companies that have had a poor stock performance one year tend to deliver excess returns in the subsequent period.

Window Dressing

Some funds proudly display an overweight in the year’s winners at year-end, which can lead to an extra boost for these stocks. However, the year’s winners may perform poorly in January as some investors wait to sell their winners for tax reasons until right after the year-end.

Index Adjustments and Pension Funds

At year-end, index adjustments also occur, leading to forced rebalancing and price-impacting buy and sell flows in certain stocks. Additionally, new pension funds are scattered across the market at this time.

Conclusion

Year-end is a good time for spring cleaning and adjustment of your stock portfolio. Take the opportunity to rebalance your portfolio weights to the warranted levels, as well as look to exploit blind reallocations due to window-dressing and year-end effects like Dogs of Dow, small caps, and forecast re-sets. There is always something to invest in, and large-cap stocks in your home market may not always be the best option. Look around for other opportunities.

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