Monday, November 01, 1999

Y2K may delay 'January effect'


Small stocks could thrive

BY PHIL SERAFINO
Bloomberg News

        The turn of the millennium might restore the U.S. stock market's “January effect” to its rightful place on the calendar.

        For much of the 20th cen tury, small stocks outperformed larger issues in January as investors bought back shares sold for tax reasons at year-end. The effect migrated into December during the 1990s as investors became more familiar with it and tried to get a jump on the anticipated gains.

        Investors might be loath to pour money into small stocks this December, though, because of concern that the Year 2000 computer bug might disrupt companies or financial markets. That means small stocks are unlikely to rise before the new year begins.

        “There's good reason to expect a true January effect,” said Satya Pradhuman, director of small-stock research at Merrill Lynch & Co. “If there's nothing truly disastrous with the change of the year, the market will come back” to investing basics.

        For investors in small stocks, January effect basics suggest that the shares will lead a market rally in January. Many sell for lower price-earnings ratios than large compa nies even though they have faster profit growth. And small stocks have outperformed large stocks during January in 57 of the past 74 years, according to Prudential Securities Inc.

        The “January effect” reflects investors' purchases of stocks sold at the end of the previous year to lock in losses. The sales allow them to report the losses on income-tax returns and to offset any capital gains.

        Stocks also typically rally in January as investors use year-end bonuses to buy shares or put money into retirement plans such as individual retirement accounts and 401(k) plans.

        Investors have known about the pattern for years. It was identified in a 1976 study by academics Michael S. Rozeff, now of the State University of New York at Buffalo, and William R. Kinney of the University of Texas.

        More recently, investors looking to get a head start began putting more money into small stocks during December. The result: During the past seven Decembers, the Russell 2000 Index of small-company shares beat the Standard & Poor's 500 Index, representing the largest U.S. companies. In January, the S&P 500 won for the past six years.

        This time might be different because of the so-called Y2K glitch, the possibility that computer programs will read the 00 in 2000 as 1900. The worry is that the bug will cause breakdowns in computer systems, resulting in lost business or expensive repairs and cutting into company profits.

        Mr. Rozeff said investors might be worried enough about the problem to cause small stocks to decline in December and rise in January. “If a lot of people decide to hold cash, you could see some effects on stocks,” he said, though he added that concern about Y2K has been overblown.

        Even investors who expect Y2K to come and go without a hitch might be reluctant to load up on small stocks in December. There's concern that trading might slow down as the year ends, making it more difficult to buy or sell stocks at the market price.

        The possibility of a lack of “liquidi ty” might prompt them to stick with the most actively traded stocks, such as those in the S&P 500 and to avoid small stocks because they tend to be less active.

        “People are concerned about what the market's liquidity is going to be like in December,” said Steven DeSanctis, director of small-stock research at Prudential Securities.

        There's one more reason to expect a true January effect: Small stocks are on track for their worst year since 1994, as the Russell 2000 has fallen 2.2 percent. “By that logic, you may see a little more tax-loss selling” by individuals, Mr. Rozeff said.

        Some investors aren't buying it. They expect another late-year rally in small stocks because there's little to fear from the Y2K bug.

        “I don't think you'll see anything different,” said Andrew Abrams, a money manager with CWH Associates Inc., which invests $90 million. “The rally will happen in December, maybe even November, because the market tends to overanticipate things.”

        In addition, while individual investors can sell for tax reasons through the end of the year, the tax year for most mutual funds ends Oct. 31, said Steven Yeary, senior small-cap portfolio manager for Value Line Asset Management Inc. That means managers of the funds do their tax-related selling before then and are looking to buy in November and December.

       



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