The October to January effect, also known as the turn-of-the-year phenomenon, is characterized by the tendency of stock prices to experience an uptick during the month of January. It was first described by investment banker Sidney B. Wachtel, who analyzed the seasonality of the Dow Jones Index spanning from 1927 to 1942. His research revealed that, in 11 out of the 15 years studied, stocks outperformed the broader market between December and January.
My own observation is that this phenomenon starts in October and ends by early February. This phenomenon is underpinned by two primary hypotheses.
The first is tax-loss selling. From October to the middle of December, investors strategically sell stocks in which they have incurred losses. This maneuver is aimed at reducing their tax liability on net capital gains and, consequently, exerts additional downward pressure on the prices of these underperforming stocks. In January, the funds generated from these sales are typically reinvested, leading to substantial returns during the month.
Second is window dressing. As the fourth quarter starts, portfolio managers adopt the practice of divesting from underperforming and risky stocks. Instead, they maintain cash positions and allocate funds to blue-chip stocks, thereby presenting a more conservative year-end portfolio appearance. This behavior is motivated by the desire to look respectable to clients who review their holdings typically at the end of the year. Portfolio managers want to avoid holding “big losers.” Subsequently, in January, the proceeds from these sales are reinvested, contributing to notable gains during the early part of the year.
During the month of October, I look for stocks that have high financial strength (Altman Z-Scores of over 3, which indicates very low likelihood of financial distress), but have for whatever reason declined during the year and may be subject to selling due to tax-loss harvesting or window dressing. My strategy is to buy some of these stocks in the October to mid-December period and then sell them in January, thus taking advantage of this seasonal pattern. While nothing is guaranteed, I have made money more often than not, using this strategy. The trick is to buy financially solid companies with high institutional ownership (at least 60%) that are trading close to 52-week lows. I also like to see some recent insider buying. The high institutional ownership ensures liquidity and a professional investor base who are motivated to tax-loss harvesting and the "window dressing" behaviour.
Some stocks which are candidates for my October to January trade are as follows.
Tyson Foods
Tyson Foods Inc. (TSN, Financial) has been hit hard this year and is trading near five-year lows. The company is a producer of animal proteins foods. Chicken and beef are its two largest segments, each comprising about one-third of U.S. sales. Prepared foods constitute roughly 20% of sales and include brands like Tyson, Jimmy Dean, Hillshire Farm, Ball Park and Sara Lee.
The company was hit hard due to inflation, but now with inflation coming down, I expect the stock to bounce back. Tyson has a good GF Score of 88 out of 100 with strong numbers in growth, profitability, financial strength and value. The only thing lacking is momentum. Institutional ownership is over 70% and insiders have been buying the stock. Further, it has an Altman Z-Score of 3, indicating that it has low probability of financial distress.
Jack Henry & Associates
Jack Henry & Associates Inc. (JKHY, Financial) develops financial software for medium-sized banks and for payment processing. The company took a hit earlier this year following the bank failures. However, the hit was ill-deserved and I am confident that the company will recover.
The company is very high-quality with perfect predictability scores and a very high GF Score of 96 out of 100. Institutions own over 60% of the stock and insiders have being buying. Further, the Altman Z-Score is robust at 8.51.
MarketAxess Holdings
MarketAxess Holdings Inc. (MKTX, Financial) runs a prominent electronic platform for fixed-income trading, connecting brokers and dealers with institutional investors. Its core focus revolves around credit-based fixed-income securities, and its primary trading products are U.S. investment-grade and high-yield bonds, Eurobonds and emerging market corporate debt. In recent times, the company has embarked on an expansion strategy, venturing into Treasuries and municipal bonds. This expansion was facilitated by the acquisitions of LiquidityEdge in 2019 and MuniBrokers in 2021. Further, MarketAxess provides pre- and post-trade services, a spectrum of offerings enriched by its acquisition of the Regulatory Reporting Hub from the Deutsche Börse Group in 2020.
MarketAxess has a very high GF Score of 97 out of 100 and perfect predictability score. With a high Altman Z-Score of 12.76, the company is almost 80% owned by institutions and recently the CEO has been buying stock, which is indicative of value. Based on historical ratios, past financial performance and analysts' future earnings projections, the GF Value chart suggests the stock is significantly undervalued. I expect the stock to bounce back next year as its appears the Federal Reserve's tightening cycle is nearing its end and bond prices are expected to recover and trading volume should increase.
