The Leaders of January’s Jump Give Bulls Comfort

by Dan Burrows | February 2, 2012 12:19 pm

Stocks started the year with their best gains since 1997, and if you believe in the January effect[1], 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[2]. 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[3]) performance for the year-to-date, and you can see why InvestorPlace Editor Jeff Reeves named Alcoa[4] 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[5] — 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.

  1. the January effect:
  2. InvestorPlace writer James Brumley:
  3. AA:
  4. InvestorPlace Editor Jeff Reeves named Alcoa:
  5. benchmark for riskier small-cap stocks:

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