Trading theories are a dime a dozen.
- The first half of the year tends to bring better returns that the second half.
- Dow Jones Industrial Average stocks whose price was beaten down in the previous year have a tendency to outperform the rest of the DJIA in the following year.
- There’s even the theory that markets in the northern and southern hemispheres predictably succumb to the winter blues, or Seasonal Affective Disorder.
But none are dying such a severe death, like the theory of the January effect, or the “expected” time of year when tax conscious investors sell stocks to write off losses against capital gains. The “tax sell-off” would depress stock values lower until buyers came back in early January.
And, yes, for awhile it was a flourishing, profitable theory. Bullish January effect theorists will remind you that from 1925 to 1993, small cap stock outperformed large cap stocks in January in 69 of 81 years.All you had to do was buy small cap stocks in mid-December and hold until the last day of January. It was like having a license to print money, as small caps, on average, returned 7% every January as compared to 2% for large caps.
But it’s time has come and gone as an ultra-reliable theory. Even as a small cap investor, I wouldn’t buy into it as a useable modern day theory. Instead, I’d buy value among the small caps, ignoring the theory.
Since 1994, for example, it’s had off and on years. Comparing the Russell 2000 to the Dow, using the dates of December 1st to February 1st as my parameters, for example, I found that in:
- 1994, the large caps stocks outperformed small caps
- 1995, the large cap stocks outperformed small caps
- 1996, the large cap stocks outperformed small caps
- 1997, the large cap stocks outperformed small caps
- 1998, the large cap stocks outperformed small caps
- 1999, small cap stocks outperformed large caps
- 2000, small cap stocks outperformed large caps
- 2001, small cap stocks outperformed large caps
- 2002, small cap stocks outperformed large caps
- 2003, small cap stocks outperformed large caps
- 2004, the large caps stocks outperformed small caps
- 2005, the large caps stocks outperformed small caps
- 2006, small cap stocks outperform large caps
- 2007, the large caps stocks outperformed small caps
Truth is, while the theory is still used, it’s not as reliable as it was from 1925 to 1993.
If you want to test the 2008 January Effect theory, be my guest. But with the wild swings between small cap and large cap out-performance makes it a high-risk bet.
Ignore Trends, Buy Value
Like I said, I wouldn’t recommend total reliance on a single theory. You don’t make money buying what every one else is buying, or doing what every one else is doing. You make money going against the herd and buying value, like my Hoku Scientific (HOKU:NASDAQ) trade in Small Cap Trading Pit, for example.
Here was an undervalued $140 million company that just inked $1.5 billion in long-term polysilicon contracts in an explosive sector. Plus, the House was working on a bill that’d boost vehicle fuel economy requirements by 40% by 2020, increase ethanol use by 2022, fuel alternative energy, including solar, and force $13 billion in new taxes on big energy companies, was stopped short because of Senate and presidential roadblocks.
Two weeks later, as the solar sector exploded, Small Cap Trading Pit readers realized a 34% gain on half of the HOKU stock position in 11 days, as the second half runs up 68% in 15 days.
And, as I’m sure you can imagine, a two-week gain is excitable.
Geoff, for instance, tells me, “Thanks I now have 150 shares of HOKU for free…. Signed up for the SC Trading Pit on Monday, bought into HOKU @ $7.92/sh on Tuesday,
Thursday AM sold enough shares @ $12.00/sh to recoup my original investment which left me 150 shares of HOKU for free 🙂 Does it get any better this? At the time of this letter that’s a $1700 gain in just 3 days or 150 free shares of a stock that has a great future.”
Francois tells me, “I had bought calls on Hoku on your alert and realized a 146% net gain in a couple of days!”
In a nutshell, ignore the volatile theories. Buy real value.
Ian L. Cooper