4 Trades For The 'January Effect'

by: BubbleBustInvesting

“Investors,” writes John M. Keynes are “largely concerned, not with making superior long-term forecasts of the possible yield of an investment over its whole life, but with forecasting changes in the conventional basis of valuation a short time ahead of the general public.” But can investors consistently outperform the market averages just by foreseeing, i.e. timing the market. Most academic economists side with Malkiel’s “Efficiency Hypothesis Theory; “The past history of stock prices cannot be used to predict the future in any meaningful way. Technical strategies are usually amusing, often comforting, but of no real value.”

However, the efficiency hypothesis theory has not discouraged stock market gurus from coming up with market anomalies that can deliver superior investment returns. One of these anomalies is the “January effect,” whereby smaller and out-of-favor stocks outperform larger stocks in the first month of the new-year—with tax and window dressing offered as the most likely explanation. This means that investors who buy these stocks in the last two months of the current year can profit by selling them in the beginning of next year.

Here are four trades we have identified for this year’s January effect:

  1. Buy homebuilders. This group has been out of favor for more than three years; and most companies trade at low single digits, e. g., Honvanian Enterprises (HOV), Standard Pacific (SPF) or upper teens like Toll Brothers (TOL), and Lennar (LEN).
  2. Buy Banks. This group has been really trashed, especially Bank of America (BAC), and Citigroup (C)—Major fund managers may feel embarrass to have them on their year-end list.
  3. Chinese Internet Stocks. Buy high-quality Chinese Internet companies that have been unfairly punished due to accounting scandals, like Sina Corporation (SINA), Baidu, Inc. (BIDU), and Sohu.com Inc. (SOHU).
  4. Momentum Stocks. Buy high-quality momentum stocks that have been out of favor for years like Cisco Systems (CSCO), Ciena Corp (CIEN), JDS Uniphase Corp (JDSU), Corning, Inc (GLW). and Ariba Inc. (ARBA); and more recent Open Table Inc. (OPEN), and LinkedIn Corp (LNKD).

Disclosure: I am long C, SPF, TOL, LEN, HOV.