If you've been to a shopping mall recently, you know that Christmas is around the corner. Investors should already be thinking about what they'll do in January. This gives us a chance to play something called the "January Effect." It's a time of seasonal small cap outperformance.
- Does the January Effect really exist, or is it a myth?
- Will it be different this year?
- Most importantly - can YOU profit handsomely?
So what's a small cap stock anyway? Basically, it's a stock under $2 billion in market capitalization and above $300 million. (Below $300 million, a stock is called a "microcap.")
And yes, the January Effect exists. It was documented in 1942 by investment banker Sidney Wachtel. He showed that small caps tend to outperform large caps in January.
So what causes the January Effect? It's likely caused by year-end tax-loss selling of small cap stocks, which are mostly held by individual investors. This selling pressure drives those stock prices down. Then, these bargain stocks are often bought back in January with the help of year-end bonus payments.
And this effect can be very powerful. The Standard & Poor's Low-Priced Stock Index during January outperformed the S&P 500 Index in 40 of the 43 years between 1953 and 1995. Small caps on average
quadrupled the returns of large caps in this period.
Now for the scary part. It doesn't always happen. In fact, the January Effect disappeared from 1996 to 1999. Then it started up again.
Also, the S&P Low-Priced Index was replaced by the Russell 2000 Small Cap Index. Not all small-cap stocks are cheap. But it's still a great benchmark for the January Effect. And since so many small stocks are dumped for tax-loss purposes at the end of the year, it generally pays to get a head start on the January Effect in mid-December.
As the chart below shows, the small cap Russell 2000 Index has been relatively sluggish, relative to large cap indexes like the S&P 500 Index, the Dow Jones Industrial Average and the Nasdaq Composite Index. This is typical of the pattern we see in small caps, in which they correct into December and then sprint in January.
In fact, the Russell 2000 is actually showing losses since the beginning of September. All the large cap indexes are solidly in the black for this time frame. So a forward-looking investor has to wonder if this small cap weakness is setting up a great buying opportunity for the January Effect.
Three More Reasons to Buy Cheap Stocks Now let me give you three more reasons to buy smaller, cheaper stocks BESIDES the January Effect.
1. Small cap and microcap stocks are out of favor. Just look at the relative underperformance of small caps compared to other indexes for the year. Since the end of February, small caps have been flat, while all the large cap indexes are up at least 10%. So, unless you think there's a big market correction coming, you should put money to work in small caps, because they're likely going to play catch-up in 2015.
2. There is real value in the small caps. A substantial number of these companies also offer solid financials in terms of profitability, balance-sheet health and corporate governance. Heck, since small caps are so diverse across sectors and industries, you could use them to construct all sorts of value and income portfolios.
3. A $500 stock doesn't triple. A $5 stock on the other hand... A small cap stock is not the same thing as a low-priced stock. A stock with a high stock price could also be a small cap. (The formula for market capitalization is share price times the number of shares outstanding.) But very often, small cap stocks are low-priced stocks. So these are the ones that can hit it out of the ballpark when it comes to performance. These are the stocks that can turn in 50%, 100%, 200% returns or more, and in a fairly short time frame, too.
How You Can Profit I usually don't use this space to beat my own drum. But I just launched a new publication focused on low-priced stocks. It uses a combination of technical triggers and fundamental analysis to find you the best stocks at rock-bottom prices. It's called
The $10 Trigger Alert. And I cover the universe of cheap stocks.
If you want to get the new trading ideas that I just sent out to my subscribers,
CLICK HERE to find out more about
The $10 Trigger Alert.
Whatever you do, don't ignore the January Effect. It can let you pull the trigger on higher profits.
All the best,
Sean Brodrick
for Free Market Café
How to Make Money on Falling Stocks... Without Short Selling or Options Most people don't know this, but there's a way to make money during a market correction without any of the usual sell-side techniques.
For example, between 2007 and 2014, Abercrombie and Fitch dropped 46%.
However, with this simple trick, you could have turned $10,000 into $25,700 - a return of 157%.
What's most unusual... with this technique, you buy the stock the same way as everyone else. To find out why this works,
just go here.
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