Secular Hold IAU & XLF 1.52%
Condition Bear Market Rally
S&P Target 940
Hedge XLU -4.05%

Position Date Return Days Call
SE 6/27/2011 15.23% 179 Hold
CLH 7/6/2011 18.59% 170 Hold
GCI 7/14/2011 -1.62% 162 Hold
CSGS 10/3/2011 17.82% 81 Hold
NLY 10/25/2011 2.99% 59 Buy
DD 10/27/2011 -5.77% 57 Hold
KBR 10/27/2011 -3.37% 57 Hold
VG 10/27/2011 -27.38% 57 Hold
WHR 11/30/2011 4.13% 23 Hold
TTM 11/30/2011 1.60% 23 Hold

S&P Annualized -12.02%
Mousetrap Annualized 6.12%
Hedged Annualized -3.83%
Secular Annualized 2.69%

Some years ago Haugen wrote a book called “The January Effect.” Once the “effect” became well known, people started jumping on board early and it started to be called “The Santa Claus Rally”.

Once THIS became well known, another well known canard comes into play: “a well known effect will stop working once it becomes TOO well known.”

We’re right on the border of that problem. But first, an explanation.

The January Effect is created by end of the year rebalancing. Some people blame this on window dressing. Some blame it on simple rebalancing, happy holiday cheer, retail optimisim,etc. I also suspect that it could be caused by people unloading their short positions because, well, tax reporting on short positions is confusing for retail investors and their accountants. You’ll probably save more money in accountant fees closing your short positions than you would gain by holding them. So, a fear of accounting nightmare driven short squeeze.

The effect is SPECIFICALLY a bump in small caps; and, I might add, value stocks.

My own model seems to gravitate toward small cap value stocks, and the basic long-only option is outperforming the S&P at a rate of 18%.

The secular version (just IAU and XLF) is outperforming the S&P by 15%.

The hedged option is only outperforming by 8%. That’s important going forward, for two reasons. 1) hedged positions require margin and are therefore charged interest by the broker, and 2) an outperformance of 18%, while below my 30% target, would still be sufficient to negate the NEED to hedge. We’ll know for sure once the test period is complete (5/31/2012), because the “bottom” should occur by then.

As I write this, my friend Len, the timing expert, has noted this evening that breadth is confirming a likely target somewhat higher than the November highs. This, too, would correspond with the small cap aspects of Haugen’s “January Effect.”

Christmas Crash, or January Effect?

Probably the latter, according to Len.

In fairness to Len, he actually made this call a couple of days ago (the day 600 billion was injected into the European banking system and the DOW jumped 300 points), but he’s reinforcing it now.

The effect is normally good for about two weeks, although seasonality for value stocks will continue past that time (per www.equityclock.com).

Tim