Beyond daily gyrations, the U.S. stock market is still positive.
The momo (momentum) crowd is bullish and aggressively buying shares. (The momo crowd controls this market.) Bears are at a loss as to how the market can rise despite a range of problems, from a slowing economy to the huge federal budget deficit.
At a time like this, is it likely that the Dow Jones Industrial Average DJIA, +0.49% could keep rising, even as much as 30% in a short time? There is a strategy that can potentially return up to 30% in three months, but to take advantage of that, investors would need to start now. The strategy is called the January Effect. It is a time-proven strategy. But there are special risks.
The strategy is based on a phenomenon that makes prices of certain stocks get depressed late in the year and rise more in January than broad-based ETFs, such as S&P 500 ETF SPY, +0.56% and Nasdaq-100 ETF QQQ, +0.99%. Stock market highs may give an extra boost to the January Effect strategy this year.
Over the past 30 years, we have made money from the January Effect about 75% of the time, broken even about 10% of the time, and lost money about 15% of the time.
Forty-six-stock list
To take advantage of the January Effect strategy, investors ought to get ready now to have their finger on the trigger. For 2019, The Arora Report has published a list of 46 stocks with buy zones and recommended position sizes to profit from the January Effect. Let’s illustrate with two very different examples.
Please click here for an annotated chart of the stock of Uber UBER, +1.56%.
Please click here for a chart of the stock of KushCo Holdings KSHB, +5.51%.
Note the following:
• Almost everyone knows Uber. Many people use Uber’s service, and Uber has been a popular stock. In contrast to Uber, not many have heard of KushCo, and not many hold KushCo stock.
• KushCo has a market cap of only $151 million. Uber has a market cap of $56 billion.
• KushCo is a pick-and-shovel stock for the marijuana gold rush. In the California gold rush, many miners went bankrupt, but the companies that made picks, shovels and machines prospered.
• While most investors have been focused on popular marijuana stocks such as Canopy Growth CGC, -1.28%, Tilray TLRY, -2.45% and Aurora Cannabis ACB, -2.89%, KushCo has been providing packaging, bottles, supplies and accessories to the marijuana industry. For the marijuana business, this is the equivalent of picks and shovels in the gold rush.
• The chart of KushCo shows that there has been some selling on high volume. In contrast, a chart of Uber does not show significant selling on high volume. The inference is that more selling in Uber stock may be ahead.
• The relative strength index (RSI) shows that both KushCo and Uber are overbought.
• The charts show that most buyers are sitting with big losses on both Uber and KushCo.
• The Uber chart shows the Arora buy zone. The KushCo chart shows the Arora buy zone.
• Arora buy zones for the January Effect have a lower probability of a fill than the regular Arora buy zones. Regular Arora buy zones are designed for a 70% probability of a fill. The reason for a different design for Arora buy zones for the January Effect is that we are not looking for fills on all 46 stocks on the list. We want to buy opportunistically if tax-loss and window-dressing selling pushes these stocks temporarily lower than would be the norm.
• The 52-week high on KushCo stock is $7.20, and the 52 week low is $1.26.
• Hypothetically, if you end up buying KushCo stock at $0.90 and it moves up to $4, that represents a gain of 344% in about three months.
• By now you may be asking why I started the column by suggesting only about a 30% return. Please read on for the answer.
Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.
Special considerations for 2019
There are five special considerations for 2019.
1. Trade war.
2. Risk of recession in 2020.
3. The Federal Reserve lowering interest rates at a time when the stock market is near highs.
4. The Elizabeth Warren factor for the 2020 election.
5. This stock market has been rising for a decade; the risk is higher than generally believed.
How dips provide opportunities
The practical way to take advantage of the January Effect is to buy dips in certain stocks that may occur for the following two reasons:
• Tax-loss selling. One strategy that is commonly employed by investors is to offset gains by taking losses on certain stocks. Such selling for tax purposes artificially depresses the price of certain stocks.
• Window dressing. Portfolio managers do not want to show investors that they were holding stocks that did not do well. Therefore, they sell such stocks, artificially depressing them further.
Two reasons behind the January Effect
The January Effect occurs for two reasons.
1. Investors buy stocks that were artificially depressed because of tax-loss selling and window dressing.
2. In January, Wall Street professionals get big bonuses. Those with big bonuses prefer bargain stocks and drive up the prices of the stocks that previously has been losers.
The conventional wisdom is that this effect applies only to small-company stocks. Our experience is that the effect is not limited to small stocks but applies to depressed stocks in general.
Do-it-yourself
An enterprising investor can use the examples of Uber and KushCo to find January Effect on his or her own. If you take this route, consider the following guidelines:
At The Arora Report, we advocate for a basket strategy to reduce risk. The Arora Report publishes a basket of stocks to profit from the January Effect along with buy zones and position sizes. Most of the buy zones are below the market. The plan is to catch down spikes. Typically only 20%-30% of the stocks on the list get fills.
All stocks with fills will not be winners; there will be losers. Even some winners will have puny returns. Typically two to seven stocks end up with monster returns. The average return typically ends up being about 30% over three months.
When to buy
The calls to buy remain valid until the end of the year. In some years the buying period is extended due to market conditions.
When to take gains
Typically gains are taken in January to March.
Managing the trades
A practical way is to put in good-till-canceled orders (GTC). Consider putting small orders in tranches spread out in the buy zones. It is important to scale in. All orders will not fill. If there are not many fills, consider raising the order prices. Every year there have been a handful of stocks on the list that came within $0.25 of the top band of the buy zone and then went on to double. For this reason, aggressive investors may want to take liberty with the top end of the buy zones. If buying above the top band of the buy zone, consider reducing the quantity to reduce risk.
If you already hold some of the stocks in the basket, consider excluding those from your January Effect list.
Caution
There may not be many fills if the stock market does not dip.
It never pays to chase price. To be successful, consider accumulating mostly on the down spikes in the buy zones.
Investors need to pay attention to many nuances to successfully execute the strategy. Furthermore, several risk-control measures ought to be taken.
Adjustments
The list of 46 January Effect stocks is regularly reviewed, and the buy zones may need to be adjusted as time goes on based on market conditions. Profit-taking signals may be provided in real time.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.