With the new year underway, signs are already pointing to another bullish year for stocks. The improving global macroeconomic picture has many analysts and strategists predicting banner results for equities, commodities and emerging markets. A broad based fund like the Vanguard Total World Stock Index ETF (NYSE:VT) might be enough for investors to take advantage of this trend. However, a certain sector combined with a seasonality pattern maybe the best way to play the upcoming year.
IN PICTURES: What Is Your Risk Tolerance?

Year-End Tax Selling
A curious thing happens in the stock market around the end of one year and beginning of the next. Many institutional money managers sell-off losers in their portfolios in December to take advantage of tax losses. Many managers reestablish positions in the new year, resulting in a rally in equity prices. These capital gains offsets combined with the general bullish euphoria of the start to the new year are known as the January Effect. (For related reading, see January Effect Revives Battered Stocks.)

However, this seasonal anomaly affects stocks of various market-caps quite differently. For investors looking at large-caps, January shows no real statistical difference between other months of the year. For investors looking at smaller companies, January proves to be your month. Research conducted by famed economic duo of Fama & French shows that small-cap stocks tend to experience most of their positive returns in the month of January. Since 1926, small-caps have beaten their larger cousins by nearly 7% on average in January. This has held true even in the last two years of the global credit crisis. What's more exciting is that this January boost is what has helped small-caps traditionally outperform larger companies over the long haul. Without it, small-caps perform roughly at the same rate.

In addition, small-caps have performed well in the first two years of a new bull market. Typically, during year one, they beat the market about 90% of time. During the second year, its 60% of the time.

Taking Advantage
For investors wanting to take advantage of this jolt in small-cap prices now is the time to act. The January effect typically only lasts for about three or so weeks. Investors, however, may want to bypass the popular iShares Russell 2000 Index (NYSE:IWM). The average market-cap of the ETF's holdings is in the $1 billion range. Top holding Riverbed Technology (Nasdaq:RVBD) has a market cap of nearly $6 billion. This market-cap range is well above what Fama & French describe in their research. A better choice maybe the iShares S&P Small Cap 600 Value Index (NYSE:IJS) with its max market-cap at only $2.41 billion.

An even better way to play the seasonal small-cap shot in the arm is through the tiniest of companies. Fama & French's research shows that those companies with market caps of less than $250 million outperform even more. Following the smallest of small, the PowerShares Zack's Micro Cap (NYSE:PZI) tracks about 400 micro-cap stocks including software developer Smith Micro Software Inc. (Nasdaq:SMSI) and specialty chemical producer Quaker Chemical Corporation (NYSE:KWR). Similarly, investors can use the iShares Russell Microcap Index (NYSE:IWC) with its average market cap of only $275 million.

Bottom Line
With 2011 shaping up to be another great year for stocks, investors may want to take advantage of the seasonality phenomena known as the January Effect. Year-end tax selling and optimism about the next 12 months bodes well for smaller companies. By adding or increasing exposure to small-caps during the first month of the year, investors can profit. The aforementioned micro-cap ETFs as well as the First Trust Dow Jones Select MicroCap (NYSE:FDM) are a great way to add that portfolio weighting.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares JPMorgan USD Emerg Markets Bond

    Learn about the iShares JPMorgan USD Emerging Markets Bond fund, which invests in bonds of sovereign and quasi-sovereign entities from emerging markets.
  2. Mutual Funds & ETFs

    ETF Analysis: SPDR Dow Jones International RelEst

    Learn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
  3. Active Trading Fundamentals

    How Hedge Funds Front-Run Index Funds to Profit

    Understand what front running is, and learn how hedge funds use this investing strategy to profit from the anticipated stock buys of index funds.
  4. Mutual Funds & ETFs

    ETF Analysis: Schwab US Large-Cap

    Discover how the Schwab U.S. Large-Cap exchange-traded fund is managed, the index it tracks and the investors for which it is most appropriate.
  5. Mutual Funds & ETFs

    ETN Analysis: Rogers Intl Commodity Energy Total Return

    Learn more about the Rogers International Commodity Total Return, which is an exchange-traded note that tracks a broad index of commodity futures.
  6. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  7. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  9. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  10. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Emerging Markets Small Cap

    Learn about the SPDR S&P Emerging Markets Small Cap exchange-traded fund, which invests in small-cap firms traded at the emerging equity markets.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Bear Closing

    Purchasing a security, currency, or commodity in order to close ...
  4. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  5. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  6. Sucker Yield

    When an investor has essentially risked all of his capital for ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!