How to profit from January Effect

The stock market has broken the tradition of a prolonged correction in December this year for the first time in five years as the market rally that everyone was expecting came too early this month.

Despite a volatile ride last week, the PSE index ended this seasonal correction that started in November with a 2.7-percent gain right before the start of the last five trading days of the year. This uptrend may further strengthen market tendency to rally toward the end of the year as shown by historical statistics where the so-called Santa Claus rally has always occurred 80 percent of the time in the last 10 years with an average gain of 2 percent.

The momentum from the increase in buying activities from this rally has helped push the market to trend higher up to the first week of the new year. Historical data showed that this so-called January Effect had occurred 65 percent of the time for the past 20 years since 1997 with an average gain of 3.9 percent.

A closer look at the past 10 years shows similar probability of 60 percent with an even higher historical gain of 4.2 percent. In other words, if you start buying today in anticipation of a rally by yearend, there is good chance that share prices may continue to go up until the first week of January, for a total return of 6.2 percent.

Although past performance is no guarantee of future results, betting on stocks with high probability of advancing during the January Effect may be helpful by looking at their historical share price performance.

Let’s start with the PSE Index stocks. Among the 30 stocks in the group, only San Miguel Corp. has consistently risen during the first week of January in nine of the last 10 years with an average gain of 4 percent.

The other index stocks with 80 percent historical probability are Ayala Land (+5.1 percent), Semirara Coal (+6.1 percent) and Universal Robina (+6.3 percent) while those with 70 percent probability include Aboitiz Equity Ventures (+3.8 percent), Aboitiz Power (+3.5 percent), ICTSI (+3.4 percent) and PLDT (+5.1 percent).

It is also interesting to note that during this period, the riskier, small cap stocks that have market capitalization of P2 billion or less have historically outperformed the larger cap stocks with an average return of 9.4 percent in 70 percent of the time for the past 10 years.

Average returns become less as market capitalization increases during the January Effect. Mid cap stocks with market capitalization of P2 billion to P10 billion have average returns of 7.9 percent while big cap stocks with market capitalization of P10 billion to P200 billion have returns of 6.6 percent. The mega cap stocks with over P200 billion capital have 6.4 percent returns.

Among the notable nonindex stocks that have outperformed in at least 70 percent of the time for the past five years are Manila Water (+4.3 percent), National Reinsurance Corp. (+5.7 percent), Suntrust Home Developers (+4.8 percent), Vitarich (+10.3 percent), Century Properties (+8.5 percent), Sta. Lucia Land (+4.3 percent), Engineering Equipment (+7.7 percent), PXP Energy Corp (+7.5 percent), Rockwell Land (+7.4 percent), Apex Mining (+14 percent) and Phinma Energy (+8.2 percent).

Investors tend to buy riskier securities at the beginning of the year when they expect the New Year is going to be a good one, but as the year evolves, the strategy slowly shifts to less risky, more reliable stocks.

Following the historical pattern of the market, it may be beneficial to include some promising, small cap stocks in your portfolio while balancing the risks with larger cap stocks for stability to maximize returns at start of the year. You can adjust your investment allocation as risk and reward outlook changes during the year.

While it may be profitable to take advantage of this market anomaly every January, bear in mind that the strength of the advance shall always depend on how positive investors expect the year 2018 to unfold.