Will the January Effect bring big gains?
If the market has taught us anything, it's that many of the traditional seasonal effects can't be counted on anymore.
The "January Effect" holds that small-cap stocks typically rally in the first month of the New Year. The numbers support this trend all the way back to 1925, with smaller stocks outperforming the broader market most years, and most of the gains occurring in the first two weeks of the month.
This is not an urban legend. Historically, the NASDAQ Composite has closed January higher than it started nearly 80% of the time across its 38-year history. It's hard to argue with data like that.
The jury's still out on what causes this turn-of-the-year surge. Some folks think this seasonal occurrence is caused by institutional managers taking more risk in the beginning of the year. Others think it's caused by new pension funding and surging trading volume after the holidays.
Another common theory is that individual investors who sold stocks to claim a loss on their year-end tax returns are now reinvesting. The reality is that it's probably a combination of all of these reasons and other variables that aren't as easy to track.
Now, if the market has taught us anything in the last 24 months, it's that many of the traditional seasonal effects can't be counted on anymore. So will the January Effect be squashed by market pressure, or will it actually be amplified this year?
I actually think it's coming in force. Here are some of the reasons why, plus three stocks set to benefit from the January Effect.
Pension-funding and trading volume. I work a lot with pension funds, and I know first-hand that we're entering the seasonally strongest time of year for these institutional investors. While large cap stocks may not be as affected, a little volume goes a long way for small cap stocks, and pension funders can really cause smaller companies to break out with just a single purchase of shares.
Positive sentiment. Many economic indicators are turning positive, most notably the impressive +3.5% preliminary GDP report for the third quarter. The broader markets have set new highs for the year, and the Dow is now well above the 10,000 mark. Add to that the holiday season raising investors' spirits, and you'll see that traders are in a buying mood.
The bulls are still winning. The Dow Jones is up about 60% from the March lows, and the broader market is up 10% since October 1. It's hard to ignore performance like that. There's still a tremendous amount of cash sitting idly on the sidelines, and those investors reluctant to jump into the market are finding fewer reasons to sit out this rally. I expect these cautious investors to dump their cash back into stocks over the next several weeks.
Easier year-over-year comparisons. Thanks to a year of extensive cost-cutting, by the time fourth-quarter 2009 earnings are announced in early 2010, the S&P 500's earnings could be up over 200% on average, thanks to easier year-over-year comparisons -- giving investors even more reason to celebrate. This will certainly add fuel to the rally in January.
Continued low interest rates. Fed Chairman Ben Bernanke has made it clear to investors that he's going to keep interest rates low until there's proof that the economy is picking up steam. Inflation is a real long-term concern, but right now the Federal Reserve is determined to pump the market full of liquidity. That's always a plus for the bulls.
Small Cap Stocks to Ride the January Effect
As I mentioned before, small cap stocks benefit most from the January Effect. To help you make the most of this trend, here are three small but very innovative companies I expect to see surge in January 2010.
Ebix (EBIX): This company sells insurance industry software products and services worldwide, but is not your standard IT firm. The company's Ebix.com web site acts as an online auction house for auto, home, health, life and other types of insurance, and Ebix gets a fee on each transaction. This helps individual and institutional clients get the best deal.
Customers are clamoring for Ebix's innovative approach to insurance, since the auction format helps keep rates low when cost-cutting is a top priority. Just look at the company's latest numbers for proof of its success. In its latest quarter, EBIX topped estimates after reporting the highest quarterly revenue and profit in the company's 33-year history. (P.S. This is a great time to buy Ebix -- the shares will split 2-for-1 next month.)
China Green Agriculture (CGA): This pick is one of my favorite international stocks. CGA is an innovative organic fertilizer giant in China and produces approximately 132 agricultural products that are sold in 27 provinces.
Since farming is the #1 industry for many rural Chinese communities, China Green Agriculture is tapped into a huge revenue stream. The company reported recently that its profit for the first quarter increased 50% compared with last year thanks to the launch of a number of new innovative products in recent months. Going forward, CGA lifted its guidance and should see similar success in 2010.
Green Mountain Coffee Roasters (GMCR): While there are a lot of coffee gadgets to choose from, Green Mountain has a technology that stands alone and really does it right. GMCR has seen runaway success thanks to its innovative Keurig single-cup brewing systems for office and home use.
The K-Cup is a truly innovative product, bringing gourmet drinks directly to consumers at a much lower cost but at the same high quality. In November, GMCR reported its quarterly profit doubled thanks to a whopping 70% increase in sales of its K-Cup products. The company also raised its full-year earnings guidance. This is clearly a stock that is on the rise and a great buy for 2010.
And for details on five more innovative small caps to buy for 2010, click here.
At the time of this writing, Louis Navellier owned shares of EBIX, CGA and GMCR in personal or client portfolios.
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