Befriend The December Volatility!

Matt Thalman - Contributor - ETFs

As we roll through the second week of December, the markets seem to be going a little crazy as the year comes to an end. From January 1st until November 28th of this year, the Dow Jones Industrial Average had gained 7.02% while the S&P 500 was up 10.6%. But, over the first week and a half of December, the Dow has lost 1.68% while the broader S&P 500 has fallen 2.04%.

Furthermore, the bulk of those declines came earlier this week when the markets closed lower Monday, Tuesday and Wednesday. And not only did the major indexes end the sessions off the mark, but their intraday lows put the indexes down by more than 1.25% on two of the three trading sessions.

The downward pressure being felt earlier this week could easily be blamed on a number of things which I am sure they were by many of the pundits out there; oil prices falling, oil prices rising, issues in Europe and Draghi not doing enough, slowing growth in Asia, weak growth numbers here at home, a poor start to the holiday shopping season, the list could go on and on. But, I personally don't believe any of those reasons are why the market has recently been falling.

The December Dive

Every year in December a weird thing happens to the markets, the volatility increases and selling begins for no apparent reason. As I indicated above, we are currently experiencing a substantial market dive and likely for no real good reason. This same sort of crash happened last year when the Dow lost 1.33% from December 1st to December 17 and the S&P 500 fell 1.39% during that time frame. I personally believe this crash is caused by large institutional investors whom are rolling over their portfolios before the end of the year.

Selling both winners and losers at the end of the year is what some investors do. There are countless reasons why one would close positions at this time of the year, with the biggest one being taxes. One would sell their losers to help offset the taxes they would owe for capital gains on other investments. Other reasons may be to hide poor performers from the funds investors, or even to hide big winners so that others will not know what the fund is holding.

So other than a feeling, what evidence is there that large investors are chroming their portfolios?

Higher market volumes. During the first week of December, the Dow was averaging 83 million shares being traded. This week, the index has traded over 100 million shares each day. The S&P 500 has had a similar increase in trading. That sort of increase in volume during a time when no big market moving news is hitting investors hands and when it would make sense for some investors to sell shares, is evidence to me that the markets are still healthy and just currently experiencing a false fall.

The January Effect

Investing is all about finding opportunities, based on what is happening within the markets, and capitalizing. The December Dive presents one such opportunity for investors to capitalize on due to what is known as the January Effect. The fall we experience in early December, which is due to money coming out of the markets, in the past has caused stocks to rise in January as that money was again put to work. Since this became well-known by market participants, many have begun buying stocks back in late December to get ahead of the crowd. (Which may be what we are experiencing today as the major indexes are all up more than 1%.)

So how do you play it?

First and foremost, buy when the market falls. The first three days of this week would have been great buying opportunities as proven by the rise in stock prices today. A simple S&P 500 ETF such as the SPDR S&P 500 ETF (SPY), which is up more than 1.3% today, would be a great start. This ETF gives you diversity in nearly every industry while putting your money in the largest, safest companies around. But don't worry if you didn't buy today because that ETF is still down 2.28% over the past five trading days, even after today's climb, and if the January Effect plays out, it will likely end the month higher than it is today.

Another ETF to play would be the iShares Russell 2000 ETF (IWM). This ETF focuses on a wider range of stocks and gives you exposure to small capitalized companies, which have performed wonderfully over the past nearly 40 years. The editor of Stock Trader's Almanac, Jeffery Hirsch, recently noted that a portfolio of small-cap stocks which hit their 52-week lows in mid-December between the years 1974 and 2012, outperformed the market over the next two and a half months by 9.5% in 33 of those 38 years.

At this time, I would continue to stay away from the industry focused ETFs, especially anything to do with commodities because of what is going on within the energy sector and how that affects the price of other items. The problem with hitting one industry now is that it's too difficult to predict where that new money will flow. Spreading your investment out through an indexed ETF will provide both safety and a strong return.

Final Thoughts

Playing the December Dive and the January Effect may be a great way to gain a few percentage points on the market. If you find yourself sitting on a pile of money because you yourself sold some losers or you just haven’t made your IRA contributions for 2014 yet, and then now would be the time to buy. Waiting until the beginning of 2015 just because you don't have the time now, may be a costly mistake.

Matt Thalman Contributor - ETFs

Disclosure: This contributor has no positions in any stocks mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.