Is January Effect Alive in 2016? Small Cap ETFs in Play

After a bumpy ride in 2015 and a sluggish start to 2016 with a long list of worries, investors are concerned whether the “January effect” will actually take place this year. This is especially true as January effect is a seasonal anomaly in which investors redeploy their capital in the stock market after a sell-off in December to create tax losses. This pushes up the stock market in the first month of the year, if we look at historical trends.

While large caps tend to perform better in a rising stock market, small-cap securities have historically proven their outperformance in January. As per the Stock Trader's Almanac, the January effect has taken place 75% of the time (read: 5 Small Cap ETFs & Stocks that Beat Russell 2000 in 2015).

January Effect: A Myth in 2016?

Volatility, which was on the forefront and weighed on stock market returns last year, has spilled over into 2016. This was clearly evident from the global stock market rout seen in the first trading session of the New Year. The S&P 500 and Nasdaq Composite Index recorded their worst New Year’s Day in 15 years while Dow Jones industrial Average saw worst start to the year since 2008.

The major culprit once again was China which triggered off the initial panic and renewed concerns over the health of the world’s second largest economy and its effect on global economy. Increased tension in the Middle East between Saudi Arabia and Iran added to the market woes. Further, some of the other headwinds that plagued the stock market last year are expected to persist. These include uncertainty in the timing of the next rate hike, lower oil price, commodity slump, weakness in many developed and developing economies, and a strong dollar (read: 16 Bold ETF Predictions for 2016).

However, the Fed has spread some optimism into the U.S. economy by pulling its trigger on the first rate hike in almost a decade. This indicates that the economy has largely emerged from the impact of the financial crisis and the Great Recession and is on a firmer footing. Stepped-up economic activities, rising business and consumer confidence, increasing consumer spending, a solid labor market, gradually increasing inflation, and recovering housing fundamentals will continue to fuel growth in the world’s second largest economy.

All these would give a boost to the stock markets and small caps seem to be the perfect choice when the American economy is way ahead of the others. This is because these pint-sized stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market. These companies are small and are poised to grow higher than their already tapped out large-cap counterparts. Further, they are free from the clutches of any global malaise (read: all Small Cap ETFs here).

Given this, the January effect might take place this year especially if the U.S. economy is able to overcome global concerns. Investors seeking to capitalize on the opportunity of the January effect in basket form could consider these small-cap ETFs having a Zacks ETF Rank of 1 (Strong Buy) or 2 (Buy).

Vanguard S&P Small-Cap 600 Growth ETF (VIOG)

The ETF provides exposure to the growth stocks of the small cap segment by tracking the S&P Small-Cap 600 Growth Index. Holding 352 securities, the fund is well spread out across each security with none holding more than 1.1% of assets. Sector wise, financials takes the top spot with nearly one-fourth share while information technology and healthcare round off the top three with 17.8% share each. The product has managed $103.7 million in AUM and volume is rather weak, suggesting additional cost beyond the expense ratio of 0.20%. The ETF gained about 3% in 2015 and has a Zacks ETF Rank of 2.

iShares S&P Small-Cap 600 Growth ETF (IJT)

This fund follows the S&P SmallCap 600 Growth Index and holds a well-diversified portfolio of 341 stocks, each security making up for less than 1.4% of assets. About one-fourth of the portfolio is dominated by financials, followed by healthcare (20.3%), information technology (17.6%) and industrials (14.8%). IJT is one of the popular and liquid options in the small cap space with AUM of $3.5 billion and average trading volume of 177,000 shares. Expense ratio came in at 0.25%. The fund added 2.7% last year and has a Zacks ETF Rank of 1.

SPDR S&P 600 Small Cap Growth ETF (SLYG)
 
This fund tracks the S&P SmallCap 600 Growth Index, holding 343 stocks in its portfolio. Similar to its counterparts, SLYG is also well diversified with none holding more than 1.37% of assets and financials occupying the top position with one-fourth share. The ETF has been able to manage $603.9 million in its asset base while trades in a lower volume of 22,000 shares a day on average. It charges 15 bps in annual fees and gained 2.4% last year. It has a Zacks ETF Rank of 2 (read: 4 Beaten Down Small Cap ETFs to Buy Now).
 
First Trust Small Cap Growth AlphaDEX Fund (FYC)

This fund provides a slightly active choice as it uses the AlphaDEX methodology to select the stock. The methodology seeks to narrow the small cap space to only the best positioned growth companies, eliminating the bottom ranked 25% of the stocks. This approach results in a basket of 193 stocks, which are widely spread across securities with none holding more than 1.28% share. From a sector look, healthcare and financials take the top two spots with nearly 22% share each while information technology, consumer discretionary and industrials round off the top five. The product has $83.8 million in AUM and charges 70 bps in annual fees. Volume is paltry exchanging 37,000 shares a day on average. The ETF was up 1.2% last year and has a Zacks ETF Rank of 2.

Bottom Line

January is truly the time to get in on small-cap securities, assuming that the historical trend will continue in 2016. The above-mentioned ETFs have shown strong resilience to the sharp downturn in 2015 and this trend is likely to continue given an improving economy and a Fed rate hike.

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VANGD-SP6 GRWTH (VIOG): ETF Research Reports
 
ISHARS-SP SC GR (IJT): ETF Research Reports
 
SPDR-SP6 SC GR (SLYG): ETF Research Reports
 
FT-SC GROWTH AD (FYC): ETF Research Reports
 
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