There's a lot to look forward to in January. Snow in the mountains. Good sales at department stores. And, if history repeats itself, a nice rally for investors.
Stocks and the mutual funds that hold them tend to ring in the New Year with a gain. The Standard & Poor's 500 has moved higher in 25 of the 41 Januarys dating back to 1950.
More important, smaller equities tend to outperform their blue-chip brethren around the start of the year--a phenomenon known as the "January effect." The S&P Low-Priced stock index has beaten the S&P 500 in 35 of the past 38 Januarys, according to Yale Hirsch, author of the "Stock Trader's Almanac" and editor of Smart Money, an investment newsletter based in Old Tappan, N.J.
These rallies tend to be concentrated in the last few trading days of December and the first week or two of January. They're triggered by an easing of selling pressure on the part of stockholders who want to lock in tax losses before year-end. A January effect has been noted as far back as the World War I era, when top federal tax rates for individuals soared to nearly 70% from under 10%, giving people an incentive to time their trades. The phenomenon also can be seen in foreign markets, Hirsch says.
Small stocks, as represented by the NASDAQ composite index, are down about 18% so far in 1990. The yearly lows were reached in October and early November. That suggests many investors have been busy unloading losing positions in recent weeks so they can take the deductions on their 1990 tax returns.
Because of this weakness, some observers believe the January effect could be pronounced this time around. "1991 ought to be a perfect year for the theory to work out simply because small stocks have been under such pressure," says Richard Carney, a Los Angeles money manager who runs GIT Equity Trust: Special Growth Portfolio, a small-company mutual fund.
If you've been thinking about putting money into a small-company fund, now would appear to be as good a time as any. Of course, whenever you invest in a mutual fund in December, make sure you do so after the fund declares its capital gain distribution for the year. Otherwise, you would get the dividend and owe taxes on profits you didn't receive, says Kurt Brouwer, a San Francisco investment adviser and author of "Kurt Brouwer's Guide to Mutual Funds." This caveat doesn't apply if you're holding a fund inside a tax-sheltered plan, such as an individual retirement account.
Brouwer doesn't suggest buying simply to take advantage of the January effect, but he does recommend small-company funds. Smaller stocks have lagged the blue chips for so many years that they now appear to be the better bargain, he says. "On a relative basis, small stocks are at unprecedented valuation levels, so if you look out five years or so, the funds should do very well."
Carney, who invests in both large and small stocks, agrees with this prognosis. The two sectors, he says, tend to alternate between prolonged periods of relative strength and weakness. Since 1983, blue chips have led the market. Before that, dating to 1974, little companies did better. "We're near levels from which small caps will begin to outperform again, and I think that will happen in 1991," he says.
But because of the high volatility of small-company funds, Brouwer suggests dollar cost averaging--investing a small amount initially with modest additions each month. That way, you purchase shares at various prices--some high, some low--so you don't have to worry about market timing.
Brouwer's favorite funds in the category include GIT Equity Trust: Special Growth (800-336-3063), Robertson Stephens Emerging Growth (800-288-7726) and Pennsylvania Mutual (800-221-4268). All are no-load funds. Depending on your risk tolerance, he recommends placing anywhere from 25% to 50% of your equity fund holdings in the small-company sector.
Alston (Mac) Barrow, publisher of the Favorably Positioned Stocks & Funds newsletter of Tampa, Fla., offers a third perspective. He doesn't put much faith in the January effect, nor does he think small companies are necessarily due for prolonged superior performance.
But he does suggest investing some money in top-quality small firms, since they tend to grow faster and thus offer greater appreciation potential than mature corporations. He likes the GIT fund along with two other no-loads, Counsellors Capital Appreciation (800-888-6878) and Nicholas Limited Edition (414-272-6133).
Barrow recently turned bullish on stock funds because of yet another cycle--the so-called presidential election indicator.