Stocks started the year with their best gains since 1997, and if you believe in the January effect, that portends good returns for the rest of the year. But calendar quirks and history aside, the way stocks rallied in January is perhaps most important: The “risk-on” trade came back in force. If the market has any hope of achieving double-digit returns in 2012, we’ll need to see more of this type of trading through the next 11 months.
Still, the January Effect — or the assumption that how January goes, so goes the year — actually has a pretty solid statistical track record, notes InvestorPlace writer James Brumley. A positive January means stocks have an 80% chance of posting positive results for the full year. And the stronger the returns in January, the greater the odds are for strong full-year returns.
Whether it was investor anticipation of more quantitative easing from the Federal Reserve, underinvested portfolio managers putting cash back to work in equities or a string of better-than-expected economic data, the fact is that January’s rally was pro-cyclical. That’s especially promising for more gains going forward. Defensive names lagged while sectors associated with global economic growth led the way. Optimism trumped pessimism — and confidence is key when it comes to stocks.
The three sectors that were down most in 2011 — financials, materials and industrials — rank in the top three in terms of performance so far this year, notes Bespoke Investment Group. Meanwhile, the two best-performing sectors last year — utilities and consumer staples — fell by the wayside.
Indeed, the S&P 500 rose 4.4% in January, led by the materials sector, which gained 11.1%, according to Standard & Poor’s. Few companies are as finely attuned to the global economy like those that furnish the basic materials of copper, iron ore and aluminum. Just have a look at Alcoa‘s (NYSE:AA) performance for the year-to-date, and you can see why InvestorPlace Editor Jeff Reeves named Alcoa his top stock pick for 2012.
Even more important, the financial sector posted the second-best returns last month, with a price gain of 8%. (Financials were last year’s worst-performing sector.) Furthermore, as the second-biggest sector in the S&P 500 by market cap (after technology), it’s clear a sustainable market rally is impossible without the participation of financials.
As for tech, it was the third-best performing sector, with a 7.6% gain in January, according to S&P. Tech is an early-cycle sector. Like materials and financials, it rises ahead of a broader upswing in the economy and market. Happily, the pro-cyclical sectors of industrials and consumer discretionary stocks also posted above-average gains last month, rising 6.9% and 5.9%, respectively.
The underperformers — those that weighed on the market’s overall gains — were found in the classically defensive sectors. The big dividend-payers — telecoms and utilities — fell 3.9% and 3.7%, respectively. Consumer staples dropped 1.7%. The health-care sector posted gains, but still lagged the broader market by more than a percentage point.
A more sweeping view only affirms investors’ renewed appetite for risk. The volatile, tech-heavy Nasdaq Composite gained 8% in January, while the stodgy, blue-chip Dow Jones Industrials rose just 3.4%. The Russell 2000 — a benchmark for riskier small-cap stocks — jumped 7% last month. The Nasdaq 100, which comprises the largest nonfinancial Nasdaq-listed firms, popped 8.3%.
True, January’s hot start doesn’t guarantee a great or even good year for stocks. But if the market is to continue its current trajectory, last month’s rally serves as the blueprint. A big year for stocks requires leadership from the most cyclically sensitive sectors. We’re only one month into 2012, but so far, so good.