The Bargains Are Piling Up

01/31/2012 8:30 am EST

Focus: MARKETS

Marc Gerstein

Editor, Forbes Low-Priced Stock Report

January has started with promise and it looks like 2012, while not a breakout year, will be an improvement on 2011, writes Marc Gerstein of Forbes Low-Priced Stock Report.

The month ending January 15 was definitely a good one for us. Given the way Wall Street’s extreme aversion to risk left us in the dust for much of 2011, the month of strong relative performance we just experienced feels like the breath of fresh air we need.

But as bad as last year was, we did have some good intervals even then. So we really need to wonder now if things are different this time...if the better times will prove sustainable.

The first order of business in this regard is to consider the “January effect,” a traditional tendency of losers to outperform in January of the following year. It’s not an ironclad rule; sometimes it doesn’t happen at all, and sometimes it gets pushed up to December. But it has happened often enough in one form or another to make it worthy of consideration.

And I do think it is playing some part. There certainly were more than enough opportunities to lock in tax losses, given the way the market was treating these stocks, and strong likelihoods the prices would stay depressed long enough to allow for repurchase after the passing of the wash-sale periods.

Given this, and the natural tendency to expect a pause or correction after any run-up, I would not be at all surprised to see our corner of the market take some sort of a near-term breather. But beyond that, as things stand now, I think we’re more likely than not to have a better year in 2012.

This is not to say all our economic problems are behind us. They aren’t, and are likely to stay with us for a long time (this includes problems with the euro as well as general global tensions).

But as discussed last month, we always have problems, so much so that if we want to hold out for the “right” time to invest, we might just as well secure our money as best we can under a mattress or in a hidden safe. There never has been a crisis-free right time to invest since the beginning of civilization, and we’re not likely to break precedent in 2012.

What we look for are indications that give us reason to believe we’re adapting to whatever problems are out there. Don’t expect solutions to be good—they rarely, if ever, are, given differences of opinion, debate, contention, etc. and resulting needs for compromise that characterize human society. We just want adaptations we can tolerate.

Lately, we’ve been seeing quite a bit of adaptation—bad adaptation, but adaptation nonetheless:

  • Washington, despite increasingly spectacular episodes of saber rattling, is still functioning, for whatever that’s worth. And however much the parties hate one another, neither seems inclined to push us over the edge in an election year since nobody can be really sure which side would be blamed.
  • Leaders of European nations at the epicenter of the Euro crisis have been replaced.
  • China looks like it has slowed (if one considers 8.9% growth slow, as they do) to the point where its leaders have started to ease up on the economic brakes.
  • The Middle East is still there—still tense, but still there.

The main fly in the ointment is corporate earnings, which haven’t been so hot. Going forward, there may not be much more ammunition left in the way of cost cutting.

But many economic indicators, including those related to housing, have stabilized or even shown some bounce. It may not be enough for a good economy, so mainstream stock indexes may languish.

But with our stocks having been so badly beaten down and valuations pushed to such incredibly low levels, even sluggish top-line growth may be all we need to see some improved price action, particularly since operating leverage (the preponderance of fixed costs that characterizes very small companies) can magnify the impact of sales improvement on the bottom line.

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