The January Effect

Now here's a market forecast legend that isn't just useful - you can actually understand it. There are no lengthy equations involving economic variables, and the whole thing actually makes sense.

A lot of analysts track the January effect, whether formally or informally. Standard and Poors 500 sector strategist Sam Stovall has tracked sectors since 1990 (uh oh, that "tracked it during a huge bull market" thing) and discussed the January Effect in a Chicago Tribune article recently.

The idea is this:

1. As the market, or more specifically the S&P 500, goes in January, so it goes for the rest of the year. This is correct about 85% of the time.

2. The market sectors that perform best in January should perform the best for the rest of the year. In theory, if you buy the 3 strongest sectors in January, then buy them and hold them for 12 months, you will on average beat the S&P 500. The sectors will give you about 15.4%, while the S&P 500 will give you about 10.2%.

So what performed the best in January 2007?

1. Materials (XLB): 4.3%
2. Healthcare (XLV): 3%
3. Telecommunications (VOX): 3%

I've chosen sector ETFs from a particular vendor; you could use different ETFs or sector mutual funds.

What are analysts thinking about these sectors? Materials company profits will only go up 7.3% for the year, after 42% growth for 4q 2006. Of these 3, analysts only recommend overweight in health care.

Health care would seem the obvious long term play, but I also like materials as a long term play, especially the new international materials ETF I've mentioned before (though there's no performance data on that ETF yet).

I think this is worth tracking each year.