What is the January Effect?

The January Effect is term used to denotes a phenomenon by which stocks are sold at a capital loss during the current tax year, then repurchased in the following tax year as a means of reducing tax liabilities from capital gains booked from the sale of other stocks during the same tax year. In the case of the current tax year, the selling pressure during the final weeks of 2015 may increase in those stocks that have performed especially poorly. Conversely, in January of 2016, the buying pressure may increase in the very same shares, as traders wishing to maintain positions in those stocks sold in the final weeks of 2015 repurchase them.

This tax strategy creates an artificial downward bias in late 2015 to the price of under-performing stocks and an upward bias to the price of those very same stocks in January of 2016. Due to US tax laws, the upward bias to stock prices in during the month of January is a phenomenon called the “January Effect”.

A Brief Primer to the Tax Strategies Causing the January Effect

The Internal Revenue Service (IRS) allows capital losses to offset taxable capital gains, with the result reflecting the net capital gain (or loss) derived from trading stocks during the calendar year. At the end of a calendar year, two popular tax strategies are deployed, typically, during the period between late-November (and December) and January 31 of the following year. And the best way to illustrate the two techniques are by way of examples.

In the first strategy, a trader purchases XYZ stock at $10 per share (during 2015, or previous years). The same shares are then sold on Dec. 10, 2015 at $8 per share for a capital loss of $2 per share. On Jan. 5, 2016, the same shares are repurchased at $7.85 per share. Because the repurchase of XYZ was executed within 31 days of the Dec. 10 sale, the transaction (for tax purposes) is referred to by the Internal Revenue Service (IRS) as the “Wash-Sale”. Under the Wash Sale Rule, the $2 per share capital loss may be added to the cost basis of the Jan. 5, 2016 repurchase price.

So, in this example, the $2 capital loss from the sale of XYZ on Dec. 10, 2015 cannot be used to offset other capital gains made in 2015. Instead, the IRS allows the trader to add $2 to the cost basis of the repurchase of XYZ on Jan. 5, 2016. In this example, the cost basis of the Jan. 5, 2016 repurchase calculates to $9.85 ($7.85 + $2) per share. If XYZ is then sold again during calendar year 2016, say, at $12 per share, the capital gain from the 2016 sale calculates to $2.15 per share, not $4.15 per share. Essentially, in this example, this tax strategy deferred a capital loss of $2 per share into calendar year 2016.

In the second strategy, consider the same example but with one exception. Instead of the sale date of Dec. 10, 2015, XYZ was sold on Dec. 1, 2015. Because the repurchase of XYX (Jan. 5, 2016) was executed outside of 31 calendar days from the Dec. 10, 2015 sale, the IRS allows the capital loss to incur in 2015, which then can be used to offset other capital gains made in 2015. So, if a capital gain of $5 per share was booked in another stock in 2015, say, ABC stock, the $2-per-share loss from the sale of XYZ may be used to lower the $5-per-share tax liability incurred from the sale of ABC, to only $3 per share.

In addition to the tax strategies exampled, above, another phenomenon traders should be aware of concerns strategies deployed by professional money managers, many of whom may sell poorly-performing stocks late in the year (with an eye toward regaining the position) as a way of not appearing incompetent when their stock holdings are marked-to-market and published at year-end. This face-saving technique among the professional money management community is commonly referred to as “Window Dressing”, and adds to the bullish bias to stock prices in the month of January.

Each year speculation as to which stocks may benefit the most from the January Effect begins at this time of year, including my list of seven favorites. The following seven stock are listed, below, and are not ranked by my preference:

BlackBerry (BBRY)

YTD performance: -26%

• Though BlackBerry’s dominance in the smartphone market has collapsed to a mere 0.3%, from more than 20% in previous years, the company’s niche of delivering the market’s most secure smartphones to security-conscious consumers and corporate clients may substantially raise its market share in 2016.
• What appears as evidence (nor confirmed by the company) of sold-out stock at retailers, Wal-Mart and Best Buy, may indicate a better-then-expected demand for its smartphones and a better-than-expected bottom line to 2016 quarterly income statements.
• Fourth-quarter earnings expectations are quite pessimistic, in my view. If sold-out stock at two of the largest retail outlets in the US indicates better-then-expected demand and, therefore, revenue, the consensus estimate of an 11-cents per-share loss may turn out to be too pessimistic.
• The stock trades closer to the bottom of its 52-week trading range, suggesting to me that a bias toward a negative sentiment among traders may not be appropriate, as evidence of a turnaround may be visible at this time.
• At a Price-to-Sales, Price-to-Book of 1.58 and 1.16, respectively, most traders remain unconvinced of a successful turnaround attempt. Therefore, we believe any future surprise weighs in favor of the bulls.

GoPro (GPRO)

YTD performance: -70%

• The drastic sell-off in GPRO from the Aug. 10 high of $65.49 appears to me as an overreaction to the realization of the company’s projected slower-growth potential. With revenue approaching $2 billion, percentage growth rates are expected to slow as each additional dollar added to revenue mathematically diminishes the rate of increase. As I see GPRO’s recent price action, a normal and expected market correction turned into a panic.
• In my opinion, Morgan Stanley’s assessment of GoPro’s line of action cameras (which recently heavily influenced the stock’s price), comparing the line with standard digital cameras, is incorrect. Serving a niche market with an iconic brand and leading-edge technologies don’t warrant comparative valuations with companies operating in the photographic equipment market, as Morgan Stanley suggests.
• Product introductions to new markets in 2016 may easily outstrip Morgan Stanley’s FY2016 estimates.
• Though GoPro’s doesn’t pay a dividend, the stock’s Price-to-Sales, Forward P/E Ratio and PEG ratio of 1.36, 15.43 and 0.69, respectively, indicate an approximate 20% discount to the Nasdaq 100 Index.
• The company has no long-term debt.

Basic Energy Services (BAS)

YTD performance: -66%

• Energy stocks are hated and technically oversold, providing a potentially profitable contrarian play.
• Only a modest rebound in oil and gas prices may soar the price of BAS, as the stock’s beta of 2.36 indicates a much higher-than-average volatility, especially for a company that recently traded at a market capitalization of more than $1 billion.
• Deteriorating geopolitical events in the Middle East favor an upside surprise in the energy markets and BAS.
• The long UD dollar trade has become overcrowded (by many measurements), providing added support to my thesis of an oversold energy market. The two markets are negatively correlated.
• The bear market in commodities prices has surpassed the four-year mark, outlasting many previous commodities bear markets.

Glu Mobile (GLUU)

YTD performance: -20%

• Recent evidence (post-Thanksgiving Day sales) of strong interest in celebrity-based games provides a strong case for CEO de Masi’s strategy of focusing heavily upon the company’s marketing effort to build on the glowing success of the Kim Kardashian game and sequel title. The lineup of celebrity-based releases for 2016-17 include five of today’s hottest popular culture personalities.
• No other digital-game company matches Glu Mobile’s inventory of celebrity contracts, giving Glu Mobile the lead in an overlooked and successful strategy available to well-funded digital game-makers.
• Though the stock isn’t cheap, it’s not expensive either. With a better Gross Margin and Operating Margin than the industry’s mean, the Glu Mobile’s Price-to-Sales Ratio of 1.5 (compared with the industry average of 2.54) may indicate as much as a 40% discount against its peers.

Freeport-McMoRan (FCX)

YTD performance: -71%

• FCX is a great play on a rebound in the commodities complex. As the world’s largest producer of copper, large investment capital may return to the stock faster than it left. With a beta of 2.24, the stock provides potentially good price action if I’m correct about a rebound in the commodities market.
• Management has responded appropriately to adverse market conditions. As a means of conserving cash, the suspension of the company’s $0.57 annual dividend and guidance for reduced capex spending are the right moves until the commodities markets recover.
• Though current assets (less inventory) of $2.81 billion is enough of a cushion to ride out another year of depressed commodities prices. The savings of $240 million in dividend payouts and a $1 billion reduction to capex spending for years 2016-17 add to the company’s solvency cushion.
• At a Price-to-Sales and Price-to-Book of 0.44 and 0.68, respectively, traders have already priced-in a rather dire 2016, the year I anticipate a U-turn to the US dollar’s remarkable relative strength and the commodities markets’ relative weakness.

Chesapeake Energy (CHK)

YTD performance: -80%

• With the US expected to lift bans to natural gas (NG) exports next year, upward pressure to NG prices in the US may result, in addition to an already technically oversold pricing structure of all energy resources.
• The company’s break-even NG production price of $2.50 MMBtu is among the lowest in the industry. Efficiency increases at the company’s five well sites will appear in 2016 quarterly reports.
• Chesapeake’s Price-to-Sales Ratio is a remarkably low 0.18, compared with the industry mean of 3.26. Any meaningfully positive news about the company may provide a catalyst for a tremendous short squeeze to CHK, as nearly half of the stock’s float is held short.

Primero Mining (PPP)

YTD performance: -38%

• As the gold price (in US dollars) approaches a five-year-long bear market, a bullish turn in the market price of mining shares is expected, as prices in the bullion and shares markets have historically coincided with rate-hiking cycles.
• Even if the Federal Reserve doesn’t deliver a rate-hiking cycle, confidence in the central bank and the US dollar may markedly wane, catalyzing upward pressure to the US-dollar gold price.
• The company’s San Dimas mine has achieved a remarkably low all-in cash cost of $454 per ounce of gold (including silver credits), a cut of more than half the all-in cash cost reported for Q4 2014.
• The 3,000 tpd throughput goal for the San Dimas mine appears achievable and ahead of schedule. Markedly higher production output and lower operating costs in 2016 may surprise analysts in addition to my expectation of a firmer US-dollar gold price next year.
• Primero’s projected $100 million FCF in 2016 and low market capitalization of $390 million (MC/FCF of 3.9) ranks the company at, or close to, the bottom of the list of its peers.
• When comparing Primero’s enterprise value (EV) with earnings before interest, depreciation and amortization (EBITDA) and with free cash flow, the company’s EV/EBITDA and EV/FCF of 5.02 and 8.06, respectively, are among the lowest ratios in the North American mining industry.

Trade green!

Jason Bond