It’s Time Again for the ‘January Effect’--or Is It?

You like to buy stocks when they’re down? You think 1994 is going to be a great year for growth stocks and smaller stocks, starting right away in January? Then check out this list.

These are the 12 growth-stock and small-company stock mutual funds that suffered the biggest declines in the market’s recent selloff, measured from Sept. 30 through last Thursday.

Many of these funds had been high-flyers in the first nine months of the year, when investors bid up prices of young growth stocks in such fields as telecommunications, computers, software, restaurants and gambling.

But once October arrived, Wall Street began to have second thoughts about the frenzy for these issues. The composite index of the Nasdaq Stock Market, home to the majority of emerging growth stocks, was up 16% for the year when it hit its all-time high of 787.42 on Oct. 15. The index closed Tuesday at 755.63, down 4% from its peak.

Many individual growth stocks, however, have plunged 20% to 40% from their highs. For the mutual funds that stuck with these issues, the last few months have been brutal.

What now? Growth stock fans argue that the recent selloff was nothing more than profit taking by investors who had racked up big gains in the stocks, and wanted to cash out some of their winnings. Such selling is often tax-related, Wall Streeters note. By that logic, once 1993 ends that selling should end, and growth stocks should rebound--and likewise, the funds that own them.

Historically, in fact, small stocks in particular have tended to snap back in January if they’ve been pummeled in November and December. The phenomenon is known as the “January effect.”

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The risk here is a big one, though: After three years of stellar gains in growth stocks, especially smaller ones, the bull market may simply have run its course. Even if the “January effect” occurs, the growth stocks could resume their plunge with a vengeance soon after, if the market overall crumbles again.

John Hartwell, manager of the Keystone America Hartwell Emerging Growth stock fund in New York (phone: (800) 343-2898), doesn’t buy the bear story. His fund has tumbled 6.5% since the end of September, dragged down by slumps in growth issues such as Electronic Arts, a leader in entertainment software, and Cott Corp., which makes inexpensive store-brand soft drinks.

But Hartwell insists, “I don’t have any reason to think these companies have anything wrong with them.” And it’s just too early to declare the bull market over, he says. “It would be very unusual for a bear market to unfold just as the economy is picking up steam,” he says.

At the Boston Co. Special Growth fund ((800) 225-5267), which took the biggest hit in our fund survey--down almost 9% since Sept. 30--manager Guy Scott terms this selloff “just a correction in a long-term bull market.”

His $115-million fund was hurt by large stakes in telecom issues such as Comcast Corp., mobile-phone firm Nextel Communications and telecom equipment maker Ericsson. He could have sold into the decline, Scott says, but he views the stocks as long-term bets on the enhancement of cable TV and phone systems worldwide. “I really believe the telecom revolution will continue for three, five, even eight years,” he says.

Scott also has big holdings in major airline stocks, including AMR, parent of American Airlines, and Delta. Eventually, Scott says, a stronger economy and the consolidation of weaker airlines worldwide is going to favor the U.S.-based giants, which have dramatically slashed costs and boosted efficiency in recent years.

Audrey Snell, who runs SunAmerica Emerging Growth ((800) 858-8850) in New York, also is asking her shareholders to take a longer-term view. Her fund has dropped 8.4% in recent months.

Like Scott, Snell believes that telecom will be a growth business for years, but with inevitable periodic selloffs in the stocks. “When we find a major secular trend (in business), we stick with it,” she says. Her holdings include Newbridge Networks, a computer networker for telecom firms, and cable TV equipment maker Scientific Atlanta.

She also remains bullish on beaten-down gambling stocks, including Primadonna Resorts, Players International and Promus Cos. “I see this as a very major growth industry for the rest of the decade,” Snell says. “It’s just beginning.”

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What about the basic issue of valuation--i.e., didn’t the growth stocks become overpriced relative to earnings in their summer surge?

True enough, says George Novello, manager of the Smith Barney Shearson Special Equities fund (800-451-2010) in New York. But the selloff has left many of these stocks under valued now, he says. He cites golf-club maker Callaway Golf, which at its current level of $56 a share is priced at 25 times the $2.26-a-share it’s expected to earn in 1993. Novello figures Callaway’s earnings will rise at least 30% next year. When a stock’s price-to-earnings ratio is less than its earnings growth, it’s time to buy, Novello argues.

Though stocks such as coffee-maker Starbucks Corp., comic book leader Marvel Entertainment and pet store chain Petsmart helped contribute to the 5.6% drop in Novello’s fund since Sept. 30, he says he’s been happy to buy more of those issues on the way down. “I believe you hold high-quality stocks until they’re no longer high-quality,” he says.

If the growth-fund managers’ optimism is on target, there’s money to be made here. But to buy these funds now, you need more than short-term optimism: You’d better be willing to stay invested for many years, because if the bear is on deck these funds all will get mauled much worse.

Who Got Clipped

Here are the 12 stock mutual funds in the growth-stock and small-company fund categories that have dropped the most in the market pullback of recent months.

Sept. 30 Year-to-date Fund (G: growth; S: small co.) to Dec. 16 return Boston Co. Special Growth (G) * -8.97% +16.5% SunAmerica Emerging Growth A (S) -8.44% +10.7% Dean Witter Develop. Growth (S) * -8.30% +26.6% Dean Witter American Value (G) * -7.13% +16.5% Dean Witter/TCW Small Cap Growth (S) * -7.00% (new) SunAmerica Growth (G) -6.97% +9.0% Keystone Amer. Hartwell Emer. Gro. (S) -6.50% +4.4% Kemper Funds: Growth (G) -6.26% +0.1% Keystone Custodian S-4 (S) * -6.01% +21.0% Fortis Capital Apprec. (S) -5.92% +13.3% Regis Sirach Special Equity (S) * -5.77% +14.7% Smith Barney Shear. Spec. Eq. B (S) * -5.63% +31.3%

* indicates no-load fund

Source: Lipper Analytical Services