Will the Fiscal Cliff Compromise Enhance the January Effect?

The January Effect is the tendency for stock prices to experience a general increase in the first month of the year, with the move being more pronounced among small cap companies. After a wave of selling occurs in December for tax or reporting reasons, stocks are believed to rise because investors re-enter the market. This year, the effect appears to be in full force as the market rallied after a fiscal cliff deal.

As the United States neared the fiscal cliff, a combination of tax cuts expiring and a reduction in government spending, stocks took a beating. All three major U.S. indices logged a five-day losing streak in late December. Even market darling Apple (NASDAQ:AAPL) dropped about nine percent in the final month of the year. The general belief that taxes on incomes and capital gains would increase in the new year weighed heavily on stocks. However, the major indices are showing no signs of a hangover as they begin 2013.

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In the first few hours of the new year, Congress finally agreed to a fiscal cliff deal. Income tax rates will remain the same for individuals earning less than $400,000 a year, and households earning less than $450,000 a year. Taxes on capital gains and dividends will also have the same income thresholds…