The worm turns this time each year.
Well, most years, anyway. For the last 70 years, small-capitalization stocks have outperformed large-caps in January more than 80 percent of the time.
Known as the January effect, this price bounce usually occurs in underperforming stocks sold for year-end tax losses and snapped up as bargains.
The tendency is strongest after years in which small-caps haven’t done all that well. Keeping this in mind, experts note that small-caps in 1996 have gained little more than half as much as their large-cap brethren and may be ripe for a revival.
In recent years, timing of the January effect has gradually been pushed a bit earlier as tax-law changes have encouraged many mutual funds to sell stocks earlier. Despite the volatile climate for Nasdaq issues these days, gains have already been posted in some beleaguered small-cap health-care and consumer staple stocks.
One worrisome consideration: If small-caps do not outperform big-caps in a given January, they usually go on to underperform throughout the following year.
“I think we’re going to continue to see small-cap stocks do well in their seasonally strong period of late December and early January,” predicted Claudia Mott, director of small-cap research for Prudential Securities. “Whether they continue to do well after that will hinge on whether their fourth-quarter earnings reported in mid-January look better than those of large-caps.”
Otherwise, a lot of investors playing the small-cap bounce right now may not be dedicated enough to stay in, Mott warned.
Some stocks are likely candidates for the January effect because they’re selling near 52-week lows, have underperformed the market and pay little or no dividends, according to Mott. Among these are American Buildings, Best Buy, Fieldcrest Cannon, Hechinger, Navistar International, Rollins Environmental Services, Ryan’s Family Steak and Sunglass Hut International. Other favorites are financial-services firms Oppenheimer Capital LP and ACC Consumer Finance Corp.; energy companies Forcenergy Inc., Belden & Blake Corp., Coho Energy Inc. and Aquila Energy Corp.; and cyclicals Olympic Steel and Gibralter Steel Corp.
“Small-cap stocks are due for a catchup here and are probably going to do so through February in what should be quite a good year for them,” added L. Keith Mullins, market strategist for Smith Barney. “Yet keep in mind that, as stock portfolios have become so large, there’s a liquidity issue now because it’s harder to move in and out of these small-caps, and that makes mid-caps look more attractive.”
Mullins’ emerging growth stock favorites include Dollar Tree Stores, American Residential, Tiffany & Co., Staples Inc. and Discount Auto Parts Inc.
“I think you’ll see returns on small- and mid-cap growth companies in 1997 at least 25 percent higher than the S&P 500 and the Dow Jones industrials because the larger stocks have gotten pricier,” said Jim Collins, editor of the OTC Insight newsletter in Walnut Creek, Calif., one of the most successful investment letters over the past decade by emphasizing small-cap stocks.
“While there is a little bit of a push upward on inflation, I see interest rates lower by midyear, and that is a positive for stocks even though they will be volatile.”
Collins, who viewed Federal Reserve Chairman Alan Greenspan’s comments on “irrational exuberance” as a buying opportunity, likes high-tech stocks Altera Corp. in semiconductors, PeopleSoft Inc. in software and Compuware Corp. in systems software; energy companies Forcenergy Gas Exploration and Cooper Cameron Corp.; and vitamin firm Herbalife International.
Playing seasonal games isn’t what serious investing is all about, however.
“In weeks like these, the tone and pitch of the market as it reflects small-caps can change daily, yet the growth of these stocks is very promising and we continue to remain fully invested,” said Christine Baxter, portfolio manager of the $1.5 billion PBHG Emerging Growth Fund, up 22 percent over the last 12 months with a three-year annualized return of 32 percent. “You must take a longer-term view and capture company performance as it grows from $20 million in revenues to $100 million.”
Some of Baxter’s holdings include Consolidated Graphics Inc., acquiring graphics printers; Vincam Group Inc., employee benefits administrator for small firms; NCS Healthcare Inc., pharmacy services for nursing home patients; and Natural Microsystems Corp., maker of computer products for the telephone industry.
