2021’s Losers Could Bounce Back Due to the January Effect

By TradeSmith Editorial Staff

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2021 came in like a lion in terms of stock market gains, but it’s going out like a lamb. And that’s not really surprising.

For instance, the Russell 1000 Index (IWB) of large-cap U.S. stocks soared 20.7% higher through the first eight months of 2021. But in the three months since then, the index has gained only 1.3% more.

The fall months tripped the Russell just short of the finish line with pullbacks of 7% in September and nearly 6% in November.

Like a football team that blows a big lead in the fourth quarter, stocks just can’t seem to finish strong.

But it’s clear to see why. A 20%-plus gain earlier in the year is more than enough reason for investors to cash in some of those gains at this time of year.

In the last month or so, investors most likely engaged in some end-of-year tax-planning moves. This involves selling losing stocks at year-end to offset big gains earned earlier this year.

And the selling has probably ramped up in 2021 for three good reasons.

’Tis the Season for Tax-Loss Harvesting

First, despite the 20%-plus gain for the index, plenty of individual stocks have been beaten down this year. Taking a closer look, you’ll find that 105 stocks in the Russell 1000 Index are down 20% or more this year.

So there is likely to be more year-end tax-loss selling than usual in the stocks that have performed poorly during 2021.

Second, plenty of investors are worried that tax rates are headed higher from here, and that includes capital gains rates. The Biden administration has already proposed this.

And if the capital gains tax does take a bigger bite out of your profits next year, that creates a strong incentive to book more of your gains before the end of this year to avoid potentially higher tax rates in 2022.

Third, just like the major indexes, plenty of professional money managers have also had a good year in 2021. And that creates a big incentive to “sit on the lead” through year-end.

These professionals are most likely due big incentive-based fees and bonuses based on their performance this year. So why risk blowing it in the last few weeks?

For that reason, the pros are likely doing some tax-loss harvesting of their own right now. And they aren’t sticking their necks out to buy into the recent decline either.

The silver lining to this scenario is something called the January Effect. And it could be a powerful moneymaker for you in 2022.

Could the January Effect Boost This Year’s Losers?

The January Effect is simply the tendency for stocks to consistently move higher in the first month of the year. It’s believed to be driven by the very same investors — pro and retail alike — who engage in year-end tax-loss selling. They often want to put that money right back to work at the beginning of the new year.

Another possible explanation is the generally large money flows into the stock market from individual as well as institutional investors at the beginning of each month. Those money flows can be magnified during the first month of the year.

Whatever the reason, or combination of reasons, the January Effect has historically given stocks a reliable boost in the first month of the year. And that boost is particularly true for stocks that declined the most during the previous year.

With that in mind, I took a closer look at the Russell 1000 list of losers for 2021 at the end of last week.

To my surprise, I found few in the Red Zone. But most were in the Yellow Zone, a neutral rating. And many of the stocks in this group still have Bullish ratings from our system.

But I was most interested in stocks that were still in the Green Zone despite declining in 2021.

How to Screen for Potential January Effect Bounce-Back Stocks

Could these be good candidates to buy in the first week of the New Year to take advantage of the January Effect? Quite possibly.

To screen for these stocks yourself in our system, simply go to the TradeSmith Finance Market Outlook page, under the “Markets” tab at the top of the page, and click on the Russell 1000 Index (IWB) (or any other index you like).

This will take you to the Distributions tab for the index. On the left side of the page is the Current Stock Rating Distribution widget. For the Russell 1000, you’ll notice that nearly 70% of index stocks still have Bullish ratings. Another 25% are Strong Bullish.

Now, click on the right arrow to view the Current Health Distribution. You’ll see that nearly 70% of stocks are in the Green Zone. Click on the percentage link to go to the screener for individual stocks.

On the screener page, I would normally look at the Green Zone stocks before anything else. But remember, we’re looking for losers that are primed for possible gains due to the January Effect.

On the search preferences page, I want to input specifications that result in a bigger list of stocks. So, under Health Status, I include both Green Zone and Yellow Zone.

Under the Display & Sort Results section, the default is to sort the results by Health. But here, I sort the stocks by one-year change percentage (1 Y Change %; you may need to scroll down to find this option) and Ascending (ASC). This puts the worst performers at the top of the list.

Here’s one stock that caught my eye right off the bat: Palantir Technologies (PLTR), which went public in 2020. The stock has been in the Green Zone, a healthy state, since early October, despite its recent decline.

This could be a prime January Effect rally candidate. But also note PLTR is a volatile stock, with a sky-high-risk VQ of 60.66%.

But according to our timing tools, PLTR is in a valley turn area, indicating a potential rally into late January.

I’ll be keeping a close eye on this, and other stocks on the list, for a potential January Effect bounce-back in price.