The end of the year brings holiday cheer, some employment bonuses, tax write-offs, and the January effect. The stock market enjoys the so-called January effect almost without fail, when returns on securities tend to be much greater than at other months of the year. These returns result in part from the hits that some over-the-counter (OTC) and lower-capitalization stocks take in December, when investors are generally selling for tax reasons.
``This happens every year, because people need to establish tax losses in December,'' observes Rao Chalasani, a market strategist and senior vice-president at Prescott, Ball & Turben Inc. in Cleveland. ``There's more bang on the upside in January buying, and people will get plenty of bargain basement opportunities then,'' when the stocks are bought or bought back at the lower prices.
People who establish the tax loss can then claim a $3,000 deduction on their taxes, Mr. Chalasani says. ``In tax-loss selling, if you don't have losses for the year, you can sell stock to establish a $3,000 loss. But you have to realize the loss before you can establish the loss,'' he explains.
Anyone not getting out of the market in August started losing money, and anyone not out by October certainly lost money, when the Dow Jones industrial average plunged 508 points Oct. 19.
The stock market is still experiencing volatile swings as it tries to find a trading range. Last week it closed up 108.26 points to 1975.30, after gaining 66 points on Monday, losing 50 points on Thursday and gaining almost 51 points Friday.
Factors contributing to last week's market performance included the dollar falling below 126 Japanese yen for the first time since 1949, when exchange rates were revised, and a slowing in the drop of oil prices.
Falling oil prices during the week had stemmed concern about inflation, especially when they dipped below $15 a barrel, the year's lowest point so far. Analysts say the prices could fall as low as $12 a barrel.
Each year in December, people tend to sell the stocks that have come down the most, perhaps as much as 50 percent from their highs this year. Invariably these end up being the lower-quality stocks, or secondary stocks, which do not have the track record, liquidity, or backing that blue chip stocks have.
Blue chips tend to be spared from this selling spree because some are owned by longer-term investors and institutions that have little tax consequences, Chalasani says.
Leading the stocks that are affected, OTC technology stocks particularly feel the cold winds of January; they have been decimated, according to Chalasani.
``The buys in these stocks will be as good as you would have seen since the bear market of 1974,'' he notes. Other stocks that have suffered and are therefore ripe for picking include some consumer stocks, like retail and specialty stores, and lower-priced commodity stocks, he adds.
The OTC stocks have been weak since 1983, when they fell out of favor, observes Richard Schmidt, the director of research at Advest Inc., Hartford, Conn. ``This happened when the buying power became the foreign money and the institutional money, and the money went to the blue chips. The OTC stocks have lost their traditional emphasis, which they have not regained.''
Given the market's fall, these stocks were affected even more through selling, as people moved to stocks that gave the flight to quality and stability, he adds.
The January effect has become so widely reported and well understood, however, that it might as well be renamed the December effect, says Stefan Abrams, co-chairman of the stock selection committee at Oppenheimer & Co. in New York.
``If a person tells you the market is going up in January, he's probably already bought stock,'' Mr. Abrams says. ``And if a person says the market's going down, do you think he still owns stock? The December effect accelerates the January effect; people have already started buying in December.''
One particular trading day in the middle of December reinforces Abrams's claim. Investors who had not been in the OTC market for a year or so started buying on Dec. 14, according to some brokers.
Chalasani of Prescott, Ball & Turben says buying opportunities in these secondary stocks next month might be particularly strong. ``There could be an unusual gain this January of between 30 percent and 70 percent, as people bring back to a normal level the value of the market. The market's fall greatly accentuated the January effect this year,'' he notes.
Mr. Schmidt also expects to see a strong buying opportunity in January, for reasons ranging from the 1986 tax code change and some promising market fundamentals to an end to the tax-loss, stock-selling strategies.
``There has already been a tax-loss selling in the larger capitalization stocks,'' he observes.
``And there have been a lot of gains on the books throughout the year. With these gains it would behoove people to find a loss, and it's easy to find a loss, given the market's fall.''
With people realizing that the world has not fallen apart since the market's col-lapse, Schmidt adds, investors should be expected to enter the markets and stocks should return to strong hands.
``Despite some negativism surrounding the market's fall,'' he says, ``the market fundamentals are pretty good, and a decent rally is beginning.''