Wall Street was good this year so Santa is coming to raise stock prices for all the good little girls and boys. The end of December and beginning of January have a unique effect on the stock market. It’s called the ‘January Effect’ but it should be called the ‘December-January Effect’. At the end of the year, hedge funds, mutual funds, pension funds, and insurance conglomerates all sell their losing positions in December. They want to tidy up their year-end reports and investment disclosures. It’s unbecoming of a large pension fund to be holding a loser stock. So they sell it and call it ‘tax-harvesting’. In addition, many mutual funds pay-out dividends at year-end. In order to do this, these funds need to sell stock to raise cash to pay shareholders. In addition, there is a great re-balancing of portfolios. To maintain their investment ratio, some funds will have to sell stocks and buy bonds . All of these actions combine to put downward pressure on stocks. Once this pressure on the stock market abates, Santa comes to town and stock prices levitate.
Once January rolls around, all those funds that were selling stocks become buyers. In addition, year-end bonuses and increases in 401k contributions give the market a boost. Typically the big winners are small cap stocks. This effect was first noticed in 1942. It has become less pronounced as market participants have adjusted for it but it still happens.
The above chart from LPL Financial shows how the two months have typically been positive months for the stock market (disregard the March gibberish, this was the latest version I could find).
This sets the stage for what I think will be a great rotation from unprofitable growth stocks into value stocks. I believe investors are beginning to see through the smoke and mirrors of profitless growth stocks. These stocks burn through piles upon piles of cash in order to fuel growth. They are household names on wallstreetbets and anyone who follows Cathie Wood. They are stocks like Teladoc, Shopify, Spotify, Peloton, or Twilio. They have sacrificed investor money to fuel the growth they desperately need to be attractive to a larger pool of fools. However, that pool is beginning to run dry.
With the Federal Reserve reducing liquidity in the market and signaling rate hikes ahead, these unprofitable growth stocks are going to shrivel up. The discount cash flow model used to evaluate these businesses is going to make them look a lot less attractive as interest rates rise. Investors will search for something that offers them a return on their investment instead of pipe dreams and fairy tales of unlimited growth. This is where value stocks ride into town. I am reviewing several companies that I believe have positioned themselves well for the coming rotation. In addition, inflation is still on the menu. Tomorrow I’ll update on my favorite inflation gauge as well as the Feds.