In the stock market, as in life, January is the antidote for December’s excesses.
Stocks that were disproportionately punished through the end of the year tend to see their fortunes reverse with the turn of the calendar. It’s one of the most consistent seasonal patterns that emerges from studying historical trading data.
“We call it the ‘January Effect,’ and it’s way too good to pass up,” said Sid Mokhtari, chief market technician at CIBC World Markets.
When executed properly, this trading tactic has a success rate of roughly 80 per cent, and there’s good reason to believe this year will be even better than most, Mr. Mokhtari said.
Starting in mid-November, the stock market’s biggest laggards up to that point become potential targets for tax-loss harvesting. This is a technique that involves intentionally selling a security at a loss as a way of offsetting capital gains realized on other portfolio holdings.
And last year, Canadian investors had plentiful gains to protect, considering the S&P/TSX Composite Index had its best year since 2009, with an increase of 22 per cent.
The best candidates are in a downward trading pattern and are off their 52-week highs by 20 per cent or more. For 2021, that meant a lot of materials stocks, particularly gold miners, cannabis names, and several smaller tech listings, found themselves in the crosshairs of tax-loss sellers.
Between Nov. 15 and Dec. 15 – the heart of tax-loss selling season – the S&P/TSX Global Gold Index dropped by 12 per cent, for example. Canopy Growth Corp. lost 34 per cent over that same stretch, en route to being the Canadian benchmark index’s worst performer of the year. And many of the year’s tech IPOs came under intense tax-loss selling pressure going into year-end.
Cue the January Effect. “We see it over and over. They become too oversold for the losses to continue, and there’s a natural mean reversion,” Mr. Mokhtari said. “There are a lot of bargain hunters out there who believe that what’s a big loser last year may become a big winner this year.”
Historically, a basket of Canadian stocks qualifying as tax-loss candidates outperformed the market in the month of January by an average of about four percentage points. That’s a very strong result for a single month, Mr. Mokhtari said.
Among Canadian large-cap stocks, Mr. Mokhtari identified Barrick Gold Corp., Wheaton Precious Metals Corp., Saputo Inc.,
and Canopy as prime hopefuls for a rebound this month. All are trading at, or close to, their lows over the past year.
Meanwhile, James Hodgins, an analyst at Stifel Nicolaus Canada, put together a list of beaten-down TSX names that have also been hit by index or ETF adjustments triggering additional net selling.
Yamana Gold Inc., for example, was removed from the MSCI Canada Index on Nov. 30, which forced some funds tied to that benchmark to sell their shares in the company. Yamana’s share price declined by 15 per cent in the month-long period loosely defined as tax-loss selling season, part of a 27-per-cent slide on the year as a whole.
“This double-barreled selling pressure often leads to outperformance in the subsequent three to four weeks past year end,” Mr. Hodgins wrote in a recent note.
In most cases, the new year comeback of last year’s duds tends to peter out by the end of January. But there’s an additional catalyst that could extend this year’s January Effect.
If inflation persists, and central banks start to raise rates in 2022 as expected, that type of backdrop generally plays to the strengths of value stocks, which have started to gain ground against the growth names that have dominated the market for the past several years.
“Value stocks are beginning to pick up a lot more steam relative to growth stocks, which were priced to perfection,” Mr. Mokhtari said. “And when you dig into value strategies, you also tend to find a lot of materials stocks.”
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