In the past, investors have made quick profits on small stocks by playing an annual phenomenon known as the January Effect. This rapid rise in small-cap prices during the first two weeks of the year typically follows two end-of-year events: Investors sell shares to balance gains with losses for tax purposes, and investment managers unload lesser-known stocks and underperformers to dress up their portfolios for yearend review. Then the New Year comes, and investors rush back into these small-cap stocks.
But the January Effect isn't what it used to be. One reason: Professional arbitrageurs have taken notice, and they are using the calendar to profit from small movements in stock prices. But by anticipating the January Effect, the arbs are diminishing its impact. "When such professionals enter the market, it's very difficult to predict what's going to happen," says Josef Lakonishok, co-author of The Incredible January Effect (Dow Jones-Irwin, $24.95).
Donald Keim, finance professor at the University of Pennsylvania, cites a built-in hurdle: Spreads between the bid and asked prices of inexpensive, OTC stocks are typically 5% or more. When individuals buy, they usually pay the higher, asked price, but they sell for the lower, bid price. That difference, added to brokerage commissions, can eat into the profits on any January gains.
COLD SNAP. Even sophisticated investors who've profited from the January Effect are backing off. Take Bonnie Wachtel, vice-president of Wachtel & Co., a Washington (D. C.) brokerage. In each of the past five years, she has invested about $100,000 in a dozen downtrodden small stocks, which she buys in the last three days of December and sells in January. Her average annual return over the period has hit 12%, after commissions of 3~ a share.
But last year, when the market was down, her modest portfolio fell 3.9%, compared with drops of 9% in the S&P 500 and 5% in the Dow. She would have lost even more -- 7.5% -- if she were paying commissions in line with the average 6~ a share most small investors pay.
Wachtel is still deciding whether to put in the time and effort this year to play the January Effect. She's more certain about her advice to investors: Look for bargains this month in blue chips and small stocks, and don't count on quick gains in January.