'January Effect': Early bird gets small-stock profit worm

NEW YORK -- Message to potential stock speculators: It might already be too late to profit big from the so-called January Effect, a seasonal phenomenon in which small stocks post bigger returns than big stocks in January.

The reason: In the past 20 years, the biggest gains from the January Effect have occurred not in January, but in the last half of December.

Statistics compiled by the Stock Trader's Almanac confirm this emerging seasonal performance quirk. Going back to 1987, stocks in the small-company Russell 2000 index have posted average gains of 3.2% from Dec. 15 through Dec. 31. In contrast, the large-company Russell 1000 posted gains of just 1.7%. That pattern remained in force in the final two weeks of '07, when the small-company index rose 1.6%, compared with a 0.1% loss for the large-cap index.

The performance gap narrows sharply in the month of January, with the Russell 2000 gaining 1.6% on average, less than half a percentage point better than large-cap stocks. And with the stock market staring into headwinds, including $100 oil and fears that the economy will slip into recession due to the housing bust, the outlook for stocks in the first month of 2008 is not particularly bullish.

Indeed, in the first two trading days of '08 the Russell 2000 is down 2.7%, while the bigger-cap Russell 1000 is down 1.5%.

Historically, smaller illiquid stocks have tended to fare very well in the first month of the year because the prices of these shares are typically beaten down sharply due to year-end tax-related selling. This creates value and leads to an increase in the prices of these battered stocks in January as selling for tax purposes dries up and new buyers emerge, notes Paul Hickey of Bespoke Investment Group.

"It generally pays to get a head start on the January Effect in mid-December," advises Jeffrey Hirsch, editor of the Stock Trader's Almanac.

Like most stocks, small fry benefit from the fresh cash that enters the stock market early in the year, thanks to year-end bonuses and dividend payouts.