myICLUB Blog

With the S&P SmallCap 600 index looking to end 2025 up a mere 5% or so for the year, small company stock investors are unlikely to be entirely satisfied with the year's performance, especially when returns are compared to the S&P 500’s gain of around 16%.

As investors take stock of the year and look ahead to fresh opportunities, many will watch some common indicators of likely future performance. For example, historically the start of the year often boosted small-cap stocks in a phenomenon known as the “January Effect.”

In the past, the behavior of small-cap stocks at the beginning of a year was driven by specific patterns, tax considerations, and trading psychology, leading to outsized gains. More recently, though, there has been a shift in the timing of the traditional boost to stock prices. 

Between 1953 and 1995, small-caps outperformed large-caps in January in 40 out of 43 years, giving rise to the “January Effect.”

According to the 2026 Stock Trader’s Almanac, a significant shift to this pattern is settling in, and today the “January Effect” actually starts in mid-December.

For the 38-year period from December 1987 to February 2025, the Russell 2000 averaged a 2.5% gain from December 15 to December 31, compared to a 1.3% gain for the Russell 1000. Positioning a portfolio to take advantage the January Effect now means acting earlier in December.

The Almanac attributes this phenomenon to specific market mechanics rather than fundamental corporate shifts. For instance, investors tend to dump “beaten-down” small stocks for tax-loss purposes near year-end. This selling pressure depresses prices, creating bargains for astute investors. Savvy traders and “smart money” may thus anticipate the January rebound and begin accumulating oversold small-cap stocks in mid-December to get a head start. The rally is further fueled by anticipated year-end dividends, payouts, and bonuses.

Other market trends bear paying attention to by investors hoping for signs about the market performance in the year ahead. The Stock Trader’s Almanac highlights a “January Indicator Trifecta” which, while applicable to the broader market (S&P 500), sets the tone for risk appetite that affects small-cap volatility and returns.

The first leg of the trifecta is the Santa Claus Rally. This refers to the gains made in the last five trading days of the year plus the first two trading days of the New Year and has historically averaged a 1.3% gain.

However, the Almanac warns, “If Santa Claus should fail to call, bears may come to Broad and Wall.” A failure of the market to rally during this specific seven-day window often precedes bear markets or lower prices later in the year.

The second consideration is the First Five Days Early Warning System. The performance of the S&P 500 during the first five trading days of January is a strong predictor for the full year. When the first five days are positive, the full year ends with gains 83.3% of the time, with an average gain of 14.2%.

During midterm election years (like 2026), this specific indicator has a poorer record, with the full year following the direction of the first five days only nine out of the last 19 times.

And then finally, the January Barometer presents a good indicator of the coming year’s performance: “As January goes, so goes the year.”

This indicator, devised in 1972, posits that the performance of the S&P 500 for the entire month of January predicts the direction of the market for the rest of the year. It has had an 84.0% accuracy ratio since 1950, with only 12 major errors. Every “down” January since 1950 has been followed by a new or extended bear market, a flat market, or a 10% correction.

When all three of these indicators—the Santa Claus Rally, the First Five Days, and the full-month January Barometer—are positive, the probability of a positive year increases dramatically. When this Trifecta occurs, the S&P 500 has been up 90.6% of the time.

Whatever the market brings, always remember that investing in individual stocks is not the same as investing in the market. Focusing on discovering the highest quality companies and buying them at reasonable prices is the time-tested formula for outsized investment success in any market.
 

In this issue of the SmallCap Informer, we return to a past pick in the defensive healthcare sector that investors have recently turned against but presents a good case for recovery.

Stay the course, and best wishes for a happy and healthy 2026!

— DOUG GERLACH

Subscribers can read Doug's complete commentary and the in-depth profile of our recommended small company stock in the current issue of the SmallCap Informer stock newsletter. Not a subscriber? Subscribe to the SmallCap Informer and get monthly small company stock recommendations and updated buy/sell prices for each of the ~40 high-quality small company stocks currently covered in the newsletter.