January is usually a pretty strong month for stocks, suggesting that many could see large gains to start the year if historical trends hold true yet again. This is largely attributed to the "January Effect".

What is January Effect?

January Effect is a historically observed increase in stock prices in the month of January due largely to year-end tax considerations. It is a seasonal anomaly in which investors redeploy their capital in the stock market in January after a sell-off in December to create tax losses. This phenomenon pushes the stock market higher in the first month of the year.

While large caps tend to perform better, small-cap securities have historically proven its outperformance in January. According to some market experts, the January Effect actually runs from mid December through February with the small caps continuing to outperform their large-cap cousins (read: 3 Best Performing Small Cap Sector ETFs of 2014).  

January Effect Never Looked Better

While most of the developed and developing economies are now struggling to reinvigorate growth and fighting deflation in this fear-ridden world, the U.S. economy is growing at a faster rate not seen in more than a decade. Given this, small caps seem to be the perfect choice in the present scenario where the American economy is way ahead of the others.

This is because these pint-sized stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market making them great choices in a trending U.S. market. Further, these companies are small and are poised to grow higher than their already tapped out large-cap counterparts. These fundamentals will support the surge in the small-cap space going forward and the outperformance is likely to be more evident in the first month of the year if history is any guide.

For investors seeking to capitalize on the opportunity of the January Effect in basket form, the following small-cap ETFs and stocks could be solid pure play choices if it materializes in 2015 (read: all Small Cap ETFs here).

ETFs to Consider

While there are several options in the small-cap ETF space, we have highlighted those that have gained strong momentum last month and this trend is likely to continue in the first month of 2015 given their favorable Zacks ETF Rank of 3 or ‘Hold’ rating.

iShares Micro-Cap ETF (IWC)

This ETF tracks the Russell Microcap Index, holding a large basket of 1,426 mini securities. The fund is widely diversified across each security as none of them holds more than 0.87% of total assets. From a sector look, financials and health care take the top two spots with 25.4% and 23.9% share, respectively, while information technology, consumer discretionary and industrials round off the top five.

The fund has amassed $973.5 million in its asset base and trades in volume of less than million shares per day. The ETF charges 60 bps in annual fees and gained nearly 5% over the past one month.

First Trust Small Cap Core AlphaDEX Fund (FYX - ETF report)

This fund follows an AlphaDEX methodology and ranks stocks in the space by various growth and value factors, eliminating the bottom ranked 25% of the stocks. This approach results in a basket of 448 stocks that are well spread out across each security with none holding more than 0.56% of assets. Sector wise, the product is highly diversified with industrials, information technology and financials making up for the top three sectors.

FYX is rich in AUM of $600.5 million and sees moderate volume of around 72,000 shares a day. Expense ratio came in at 0.66% and the ETF is up 4.2% over the past month.

RevenueShares Small Cap Fund (RWJ - ETF report)

This product tracks the RevenueShares Small Cap Index and offers exposure to about 600 stocks that are weighted by revenues instead of market capitalization. Synnex Corp. occupies the top position at 2.13% in the basket while other firms hold less than 1.50% of assets. In terms of industrial exposure, consumer discretionary and industrial are the top two sectors at 23.8% and 21.2%, respectively, closely followed by consumer staples (18.1%).

The fund has amassed $325.1 million in its asset base while it charges 54 bps in fees per year from investors. Volume is light coming under 28,000 shares a day on an average. The ETF added 4.1% in the last month (read: Forget Cap Weighted ETFs and Buy These Funds Instead).

Stocks to Consider

In the stock world, it is difficult to identify the stocks that will outperform in 2015. As such, we have screened for a number of criteria with the help of our Zacks Screener and have emerged with a handful of great picks for January. The eligible benchmarks include a Zacks Rank # 3 (Hold) or better, positive industry Zacks Rank, upward earnings estimate revisions and above-average returns in the last month.

Bio-Reference Laboratories Inc. (BRLI - Snapshot Report)

Based in Elmwood Park, NJ, BioReference Laboratories is the third largest full service clinical diagnostic laboratory in the U.S. providing testing services for the detection, diagnosis, evaluation, monitoring, and treatment of diseases primarily in the greater New York metropolitan area. The company has seen rising earnings estimates by 4.4% for 2014 over the past one month. The stock gained 12.7% last month and has a Zacks Rank #1. It comes under a industry that has a solid Zacks Industry rank in the top 33%, suggesting their outperformance in the coming weeks (read: Will Bio-Reference Laboratories  Continue to Surge Higher?).

Moelis & Company (MC - Snapshot Report)

Based in New York, Moelis & Company is a leading global independent investment bank offering strategic and financial advisory services in the United States and internationally. The company has seen positive earnings estimate revision of 3.5% for 2014 over the past one month. The stock gained over 4% last month and is expected to continue to rise given that it has a Zacks Rank #2 and an industry Rank in the top 23% (read: Why Moelis & Company Stock Might be a Great Pick).

Regis Corp. (RGS - Analyst Report)

Based in Edina, MN, Regis Corp. is the beauty industry's global leader in beauty salons, hair restoration centers, and cosmetology education. It is the owner, operator, and franchiser of hairstyling and hair care salons for men, women, and children in the United States, the United Kingdom, Canada, and Puerto Rico. The company sees impressive earnings estimate revisions of 20% for 2014. It added 2% last month and has a Zacks Rank #3 with a strong industry Zacks Rank in the top 12% (read: Can Regis a Turnaround on Improved Comps?).

Bottom Line

January is truly the time to get in on small-cap securities, assuming that the historical trend holds true in 2015. The above-mentioned ETFs and stocks have outperformed the broader market by a wide margin last month. This trend is likely to continue with an improving economy and a booming stock market that has boosted the appeal of these pint-sized products.