For investors who search for seasonal patterns in the stock market, a dependable rule for making profits year in and year out is the Holy Grail of investing. Yet while no seasonal indicator is perfect, some of them carry substantial weight among investors -- and thereby often become self-fulfilling prophecies.
One such indicator is the so-called January effect. But despite its name, you increasingly have to become aware of seasonal plays long before they're slated to take effect, as otherwise, more intrepid investors will beat you to the punch.
Why January matters
The January effect isn't a newly discovered phenomenon. According to The Wall Street Journal, the January effect has been around for decades -- but it still commands the attention of profit-seekers.
Over the years, academics and market analysts have worked to define more precisely the exact nature of the January effect on stocks. From its origins as a simple observation that stocks tended to have better returns in January than in other months, closer examination of the effect suggested that it was more dramatic among smaller stocks, especially those that had suffered substantial stock losses during the year.
Speculation about the justification for the phenomenon still abounds without any definitive answers. The Journal article suggests that tax-loss selling plays a role, as late sellers dump their big losers from their portfolios but then can't buy them back until after the new year starts. The resulting cyclical wave of selling pressure in December and buying pressure in January leads to the familiar pattern of share performance.
An attempt to play the effect
As with most seasonal stock movements, however, the bane of the January effect is its popularity. As more people track the phenomenon, its effectiveness wanes. But if the underpinnings of the January effect are accurate, then early discovery should merely move its price action rather than eliminating it entirely. In other words, there's hope that if you're early enough to the game, you can still reap the benefits of the phenomenon.
So with that goal in mind, I turned to the Motley Fool CAPS screener, looking for small-cap stocks that had fallen at least 50% from their 52-week highs but had not yet rebounded significantly from their steep declines. In addition, in order to allow you to get as much input as possible from the CAPS community, I only selected stocks that had at least 250 active picks from members of CAPS. Below are the stocks that met those conditions and have gotten the most attention from the CAPS community:
% Above 52-Week Low
% Below 52-Week High
No. of Active Picks
Bank of Ireland
Source: Motley Fool CAPS, as of Nov. 14.
Many of these stocks make pretty risky picks for anyone thinking about buying them, even at currently low levels. Bank of Ireland is still exposed to European sovereign debt fears, while Sequenom and Exelixis both have to deal with huge uncertainties about their respective products. Similarly, the tech companies on the list are heavily exposed to consumer demand for the electronic devices that use the components they build. Even US Airways has to deal with the seemingly perpetual stresses of the airline industry.
Should you bother?
More importantly for most investors, however, is the fact that the January effect is short-lived. Since it only deals with anticipated short-term results of around a month, it isn't much use to anyone with a longer-term time horizon. Any gains you reap from the effect would be short-term gains subject to tax at your full normal marginal rate. Combine that with the inherent uncertainty over whether the phenomenon will actually work in any given year, and it seems like a big price to pay for what essentially amounts to a gamble on stocks.
What the effect may help you with, though, is timing any purchases or sales that you already have planned. So if you're thinking about buying any of the stocks above regardless, you might want to pick up those shares sooner than later in order to avoid any potential mark-up in price due to the January effect. Conversely, if you own them but are thinking about selling, wait until January to take advantage of a hopefully higher stock price at that point.
Seasonal factors are fun to look for, even if they aren't terribly reliable. This year, pay attention to the January effect and see if it plays out, but don't bet the farm on it.
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