Historically, major stock gains usually occur in January

January 01, 1995|By James Lyons | James Lyons,New York Daily News

If small-cap stocks aren't on your mind, they should be, because January is the best month of the year for the stock market.

In what is known as the "January effect," the market routinely starts the year with a bang.

"It's an anomaly, but the historical evidence is overwhelming," said Michael Corbett, senior analyst with Investment Information Services.

Since 1945, the market on average has returned about 12 percent each year. In January, those returns average about 3 percent, or a quarter of each year's total return.

No one is sure why, but two reasons are commonly offered:

* Investors tend to dump sagging stocks in November and December to take advantage of tax losses. Come January, their cash comes back into the market.

* Portfolio managers engage in end-of-the-year maneuvers to either lock in good returns or cover up bad ones. In January, they re-enter the market with a clean slate.

The effect is especially profound on small-cap stocks -- issues whose market capitalization (price, multiplied by number of outstanding shares) is under $250 million.

Small-caps return about 6.5 percent in January, and about 15 percent for the entire year. So, about 43 percent of their total return comes in one month. This bounce has happened 85 percent of the time since 1945. (Others put the small-cap ceiling at under $1 billion; for these issues the January effect is diminished.)

According to Robert Ariel, an assistant professor of finance at Baruch College, the small-cap gains are concentrated even further.

"Of the incremental return of small-cap stocks over large-cap stocks, 80 percent to 100 percent of that comes in the first four trading days in January," Mr. Ariel said.

Small-caps do even better in Januarys after bad years. In years when the small-caps have had a negative return, these stocks have gained an average of 9 percent in the first month of the new year.

If you want to get in on the New Year small-cap surge, Mr. Corbett recommends two well-known, no-load funds: the Heartland Value Fund and the Vanguard Index Trust Small Capitalization Stock Portfolio.

But if the market is supposed to be subject to stock-dumping in December, how come the Dow Jones industrial average gained in several of the sessions?

That's because of the "Pre-Holiday Effect," Mr. Ariel's pet theory. In the eight trading days before the major holidays, the market gains a total of 4 percent, a big chunk of the market's yearly return.

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