Keeping Panic Out of Your Portfolio

To be honest, I've never thought the January effect made much sense. Supposedly stock prices were depressed by tax loss selling before Dec. 31, and then bargain hunters rushed in after the new year. But what about years in which there were few losses, and hence, not much tax loss selling? And why did stocks with big gains rise as much as those subject to tax loss selling?

Perhaps 2008 will also test the theory that stocks rise in election years. But with election day still 11 months away, and Congress rushing to enact a stimulus package, it's far too soon to tell.

As for January, the plunge has been dizzying. The Nasdaq composite, having crossed my latest buying threshold of 2575 just two weeks ago (see column of Jan. 8), was hovering just over another buying threshold this week, representing a further 10% decline. At 2299 — let's round that off to 2300 — the Nasdaq will be in bear market territory for the first time since August 2002. Other averages are similarly close to bear markets, and the battered small caps are already far into bear territory.

From a purely technical perspective, this sudden plunge feels more like the kind of selling climax that typically ends a bear market rather than the slow but steady grind that investors endured after the tech bubble collapsed (though there were some steep falls then, too). The theory is that when selling mania sweeps the market, it flushes out all the sellers, leaving mostly buyers in their wake. This sets the stage for a recovery. But I never set much store in technicians.