Want to participate in the big dance this year? Here’s some back-story from conventional wisdom that you might need to know so that you aren’t simply bumping your way along the dance floor. Mutual fund managers sell off their bad investments in December and do some “window dressing” at year end so their annual reports show that they are holding solid blue-chip stocks. The logic follows that this is particularly true among small-cap stocks. Could this be why stocks go down towards the end of the year and rise again in January?
Though the reasons for its outcome may not be so simply explained, especially in an internet-connected world of increasing transparency among investors, the January Effect turns out to be more accurate than not. Judging by the historical data of the S&P 500 cash index, this event is not a myth.
Have I seen you around here before?
Since 1928 the month of January has closed higher than it opened 71% of the time. Small caps have outperformed large caps in January about 76% of the time during that same period. So the evidence seems to indicate that if you buy stocks at the beginning of the year, you have better than even odds that your account will be more valuable at the end of a month.
But the reality is that it isn’t as easy as it sounds. January is typically a more volatile month than those on either side of it. The daily moves (whether up or down) tend to be larger than those in December or February for two simple reasons. The first is that January marks start of a new tax-year calendar (a time when more investors choose to participate in the stock market). The second is that the first earnings season of the year takes place early in January.
So when you have a lot of investors all fiscally dressed up and ready to dance, and when you have a lot of public companies putting on investor parties (that is to say, quarterly-earnings conference calls), you get the financial equivalent of speed dating. It is likely that 2012 will be no exception.
In fact, the coming year may actually feature a greater number of significant daily moves than in years past. When you consider the debt-crisis headlines likely to come out of the Eurozone and Washington D.C. in the next 30 days, you realize that investors could be in for some serious movement. Dance-hopping investors this year might find themselves in a line dance that plays out a lot more like a game of “crack-the-whip” instead of a mild little Bunny Hop.
Do you know how to dip?
But even so the prudent trader or investor would do well to watch for days where the market indexes seem to have met support. Days where the market has sold off two or three sessions in a row and has landed near a previous low might provide excellent buying opportunities for the remainder of the month.
The figure below lays out a potential roadmap for the coming January.
As you can see, the market has already signaled the lower bounds for its support level. Either January trends higher right out of the gate, or it falls a bit and then resumes. Assuming 2012 is similar to most years, there will be an opportunity to pick up a bargain. Could the 120 on the SPY be the target? It’s worth keeping an eye out for a good dance partner if the price of SPY should fall any where in the zone marked out in the graphic above. Stocks will likely be ready to move if the index whirls its way to this part of the dance floor.