At the end of every year tax loss selling and window dressing push some stocks down too far. Investors are looking to take losses on stocks to offset gains on other stocks for tax purposes. Portfolio managers are looking to unload their losers before they have to report their positions on December 31 to give the appearance they didn't make any big mistakes.
The selling pressure from both groups abates in January after the close of the year because it is too late to hide losses or reduce 2012 taxes. These stocks often rise as no one is left willing to sell at the steeply discounted prices. Hence the term the January Effect.
Because of the fiscal cliff negotiations, many investors believe tax rates on the wealthy will probably rise next year. Even if there is a deal that doesn't raise tax rates next year, the Affordable Health Care Act is already scheduled to place a 3.8% surcharge on investment income for the wealthy in 2013. This is leading tax planners to recommend investors with large gains book their profits this year to pay the lower 15% tax rate.
Normally tax planners would recommend waiting until the new year to book profits in order to get the benefit of deferring paying the taxes for an additional year. To offset large tax gains investors are also selling their losers, making end of the year trading this year even more tax sensitive than normal.
The tax uncertainty scenario has created many candidates for the annual January Effect. The best candidates are trading near their lows for the year and have either cash flow or assets that are undervalued compared to comparable companies. This year several companies with significant positions in either the Bakken or Eagle Ford meet the criteria of ideal January Effect stocks. The first Bakken/Eagle Ford stock for investors to consider as a January Effect candidate is Northen Oil & Gas (NOG).
Northern Oil & Gas is set up to be an ideal January Effect stock. The company is trading for $15.79, which is near the 12 month low of $13.79 and down from the 12 month high of $28. Northern Oil & Gas has an enterprise value of $1.35 billion. The company has 184,000 non-operated net acres in the Bakken. Most of their acreage is in North Dakota, and they have exposure to some of the sweet spots in the play. Northern also averaged 11,282 Boepd in production in the third quarter.
Based on the company's acreage position and production, Northern is trading for much less than several recent cash transactions in the Bakken. For example, in August of 2012 QEP Resources (QEP) paid $1.38 billion in cash to acquire 10,500 Boepd and 27,600 net Bakken acres.
Northern's operating partners include Continental Resources (CLR), Hess (HES), Marathon Oil (MRO), Oasis Petroleum (OAS), Kodiak Oil & Gas (KOG), EOG Resources (EOG), and Statoil (STO). Their partners represent most of the innovative drillers in the Bakken. As a non-operating working interest partner Northern gets the benefit of the technical expertise of its drilling partners. All of these companies, as well as Northern, are benefiting from a reduced differential discount between Bakken crude and West Texas Intermediate crude compared to earlier in the year. The expansion of the Seaway pipeline from Cushing, Oklahoma, to the Gulf of Mexico in early 2013 could provide further oil pricing enhancements as the discount between Brent Crude and WTI is expected to narrow.
Investors looking for January Effect stocks should be aware that some reach a low in November and early December and then climb before January as most of the sellers have already exited. Other January Effect stocks maintain selling pressure all the way into the last day of trading for the year. It would be wise to commit half of the capital to the play now and hold back the other half for a second round of buying if the selling pressure pushes the stock to new lows at the end of the year.
While Northern is a very good buy and hold prospect, the objective of buying a January Effect stock is to look for short term gains. Some January Effect stocks recover the most by the middle of January and some continue to recover into the middle of March. Investors should also consider selling half of their position in the middle of January and the rest of the position before the end of March.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.