The January Effect

Now that the massacre has come and gone, is it possible that the "January effect," the typical year-end rally that stretches into the new year, will lift stock values out of their depressed state? Answering that question, unfortunately, would require a gaze into a crystal ball.

Given that the performance of the markets toward the end of October 2000 was weak, to say the least, even the slightest signs of a rally need to be approached with caution. Further, the current economic climate does not support strong economic growth. In addition to rising oil prices and the weakening euro, we have Middle East tensions to worry about once more. At least the fear of higher interest rates has been kept on the sidelines for the moment; in fact, there was some speculation that interest rates could even go lower in early 2001. But again, that's speculation.

PREDICTABLE -- YET NOT

As a rule, the end of the year sees some unusual but predictable activity in the markets. Investors sell their losing stocks for tax purposes; institutional investors dress up their portfolios by selling securities that are underperforming. Given these two factors, we shouldn't be surprised to see prices decline during December; however, we know that investor sentiment will shift eventually. Sooner or later, prices will rise, possibly because of increased buying by investors who regard prices as being at incredible bargain levels.

The general consensus among analysts was that we could expect a rally at the end of the year or at the beginning of the next, but they doubted that prices%A0 would rise as high as they had been in April 2000. The markets are very tentative at this point, but if you want to take advantage of this rally, proceed with caution.

Typically, small-cap stocks tend to outperform other sectors during the year-end rally, but that doesn't mean that other sectors wouldn't rise at the same rate. Keep your eye on the small-cap sector by monitoring the movement of the Russell 2000 index. Watch other broader indexes such as the Standard & Poor's 500, the Dow Jones Industrial Average (DJIA), and the Nasdaq Composite. You might also want to add some sector indexes to your list. Identify those stocks within each of these indexes that have performed relatively well during a down market. If there is a rally as expected, these stocks will rise.

If your portfolio has taken a beating, you should take advantage of the year-end rally. At the same time, don't just buy stocks, only to be stuck in a fake-out rally. Get in when a sector shows signs of strengthening, but get out if you see signs of deterioration. As I write this, the market was not showing any clear signs of direction. If this pattern continues into the end of December, be very careful going into the new year.

Yes, there may be a year-end rally spilling into January 2001, and to make up for your losses in 2000, you may want to take advantage of it in any way you can. But you also want to start the year off on the right foot. Many market participants learned their lessons the hard way this past year, and we certainly don't want similar, disastrous results reflected in our portfolios again.