Typically, the first month of the year brings traders plenty of action, especially when it comes to playing counter-trend moves among the big winners and losers from the previous year. In 2012, investors who went against the grain in January were handsomely rewarded.
This year, however, the profits from this strategy might not be so easy to achieve.
The Lessons of 2012
In January 2012, investors profited by buying the worst performers of the prior year and betting against the winners. The S&P 500 returned 3.91% in January, but the best performers from 2011 returned just -0.5% and underperformed the broader market by a huge margin. (The full table with the performance of the best and worst stocks of 2011 can be viewed here). Of the top 24 stocks for which data is still available, only five delivered a return above the index.
The story was much different among the 25 worst stocks of 2011. These stocks crushed the broader market in January 2012, rising 15.1% on average. Eight checked in with returns of 20%-plus, including Netflix (NASDAQ:NFLX, +73%), Bank of America (NYSE:BAC, +30%) and First Solar (NASDAQ:FSLR, +29%).
This proved to be a genuine trading opportunity this past January, since, with a few exceptions, the counter-trend moves didn’t begin until 2012 was under way. A look back at the numbers shows that 2011’s losers remained weak right through the final month, with a horrific average return of -7.03% in December. Even without the two worst performers of the month — Sears Holdings (NASDAQ:SHLD) and First Solar, down -45% and -32%, respectively — the return for the year’s losers still was -4.31% in December 2011. In contrast, the S&P 500 rose 1.29%.
A look at the winners from 2011 shows a similar trend — very little of January’s reversal was pulled into the prior month. During December, the winners continued to deliver outperformance with an average gain of 2.73%.
No Surprise This Time Around
This year, it might be a different story as the dogs of 2012 have already begun their reversal. Among the worst 25 stocks in the S&P 500 for the year, the average return for December was 5.96%, well ahead of the 0.71% return for the S&P 500. (The full list is available here). Stocks that have already begun to rebound include Cliffs Natural Resources (NYSE:CLF), up 34.2%, and Alpha Natural Resources (NYSE:ANR), ahead 30.2%. This trend continued this morning, indicating that this reversal trade is already well under way.
Whether this early recovery was because of the uncertainty surrounding 2013 tax policy or simply investors reacting to the trend that was established at the start of 2012 is hard to say. It is clear, however, that traders who are looking to capitalize on any counter-trend move at the beginning of 2013 might already have left some money on the table.
The list of winners might provide more opportunity as the top 25 stocks of the year continued to outperform in December, returning 1.22%. Leaders included Bank of America (+17.9%) and Eastman Chemical (NYSE:EMN, +12.4%). This indicates that 2012′s leaders still might be ripe for shorting opportunities once this post-cliff rally runs out of steam.
The Bottom Line
The list of 2012’s winners and losers can still be used as a starting point for January trading, but use caution — the December performance of the stocks in these groups indicates that, at least with respect to last year’s underperformers, the cat’s already at least partially out of the bag.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.