“Always sell what shows you a loss and keep what shows you a profit.”
THE JANUARY EFFECT
The January effect is a seasonal increase in stock prices during the month of January. Analysts generally attribute this rally to an increase in the buying that comes after the drop in price that typically happens in December when the investors engaging in tax-loss selling to offset realized capital gains, prompt a sell-off.
Every year around this time we get some event of confusion at some point or another where investors scratch their heads to the tune of whether or not they should participate in "tax loss selling" assets or buying the "Santa Claus Rally". This year has proven to be no different and has been amplified by the recent tax rhetoric that exists currently.
The above is also synonymous with institutional positioning for the coming year as well. I'll try to highlight a few of the dynamics and scenarios in the marketplace currently.
The first important thing to note is that the "lower than normal" liquidity that typically exists around this time of year has, and will, allow for exaggerated moves (both to the upside and downside). This has been shown with the recent run up in the "rotation trades" in the Retail, Transports, and Financials to the upside, as well as the Tech stocks to the downside.
This has been a year with some outsized winners. However, these winners in terms of "number of winners" are lower relative to years with similar sized gains in previous years. This is in fact the nature of the "weighted index" and works in both directions. When the FAANG stocks go up, for example, they dwarf the losses that exist underneath in the underperformers. Conversely, when they go down, more stocks are required to go up to offset the losses from these behemoths.
In addition to the tech selloff and the "great rotation" taking place, we also have a FED meeting coming next week, and with it a likely rate hike. This is likely further compressing liquidity and allowing for the exaggerated moves to continue as a lack of a serious bid comes to the market.
The Fallacy of "Tax Trading"
The "smartest" money is always ahead of the curve. With that in mind, it is important to realize that the smartest money is not going to sit around until January to dump or buy their positions. They will utilize whatever timing is most beneficial to them. Specifically the fallacy that "people will wait for a new calendar year to take profits" is something I hear the common man echo ad nauseam. In reality however, smart money will take profits as the markets allow them and will take losses as the markets suggest would be an ideal time to do so. Sure, in an ideal world a buyer of assets will buy the lows hold throughout they year and sell the highs early in January to capitalize with the least tax burden. This is not a perfect world however and the market will dictate to the 1%ers when to bail. Conversely, these same 1%ers will not wait to start the "Dogs of the Dow" theory positioning.
The above confluence of events typically lead to the same type of trading that we've seen for the last week or so. Specifically, we've seen a market that can/has move(d) in either direction. We've seen a lot of outsized moves in individual names. These moves have appeared to be in-exhaustive especially to the downside (Tech). In addition to these wild swings, we've seen that any level of headlines and/or analyst ratings/changes have also produced similar outsized moves (SNAP at the time of this writing is the latest example of this trend).
SO HOW DO YOU PREPARE FOR A NEW YEAR?
The shortest answer to all of the above is to build your "Jan Effect" list now and start accumulating the names earlier in the month rather than wait for the calendar turnover. This does a few things:
- You get in ahead of the herd if your thesis is correct
- If you are correct you will be able to sell next year rather than having to hold into another new calendar year
- You will get in likely before volatility reaches a frenzy
The same will be true with selling your winners end of year. I've found that it's best to sell the biggest winners earlier in the month of December rather than later or into next year. Typically the decay on your returns will be greater than the tax hit you'll face.
An extreme example of the above is the drop in SQ. Say you had a position in SQ for most of the year, had you sold prior to the extreme drop, you would have saved yourself roughly 26% peak to trough.
Potential Setups for 2018:
IBM:
IBM mainframes handle close to 90 percent of all credit card transactions ($7.7 trillion per year.) All of the 10 top insurers, 44 of the top 50 banks, 18 of the top 25 retailer and 90 percent of the largest airlines use IBM mainframes. We are coming up on a mainframe super cycle as IBM's Z14 mainframe may give this technology behemoth a big boost. The new iteration mainframe with increased encryption power could drive revenue thanks to hacking attacks that have compromised 9 billion data records recently.
TRVG:
This name has been destroyed in recent months and at some point (soon) likely sets up a good risk reward for a snap back rally.
RDFN:
Redfin (RDFN got beaten down after its Q2 report on September 7, presumably because some investors didn't realize it already guided in its prospectus. That said, the inline report appeared to be disappointing on the surface, however, its guidance was key. RDFN it didn't disappoint, issuing upside guidance. RDFN remains a major, disruptive force in the real estate brokerage industry thanks to its lower fees and leading website, allowing it to continually gain market share.
NVDA:
Watch for any more potential days of sharp selling on this one as well as the FAANG's.
NFLX:
This one is off ~10% on basically nothing. The negative out there is that there may be consolidation in the content/distribution space by competitors. I don't buy that as a total game killer for NFLX yet though.
TSLA:
Has been range bound for weeks after a double top. Has held 300 like a champ and is on the verge of breaking out.
SYNA:
Recent AMZN news as well as the strong QTR., which was just recently produced.
CSCO:
Recent large breakout of a massive range and a sentiment shift in the name.
GS:
Potential double top breakout and a large rotation into financials as the tax bill gets jammed quickly through the house and senate to "get a win."
ULTA:
After a down year, it appears that this one has found a (temporary) floor and may get accumulated going into the new year as investors bet that the down run is over.
INTC:
After an apparent change in sentiment and a subsequent drift lower, this name is finding support at the 50D and sets up nicely into 2018.