The January Effect Gets Going Soon

We haven’t even had Thanksgiving yet and we’re already talking about the January Effect? Are you kidding me? I know, I get annoyed when I see Christmas decorations in November too. But there’s a reason that I’m bringing this up today. As time has gone on, the so-called “January Effect” has begun sooner and sooner. And the statistics have such a high batting average that we simply can’t ignore it.

First of all, let’s define what the January Effect is: This is the tendency for Small-Cap stocks to outperform Large-Caps in the month of January. There are plenty of theories out there as to why this is the case, but the one that makes the most sense to me is simply risk and position sizing. You see, if it’s your job to allocate billions of dollars, you are more likely to buy smaller-cap companies, that are theoretically more risky stocks, early in the year because if you’re wrong, you have the rest of the year to make up for it. As far as position sizing goes, the massive portfolio managers can start buying smaller, less liquid companies early, giving themselves plenty of time to accumulate shares. But either way, the reason is irrelevant, we’ll just go with the math.

According to the Stock Trader’s Almanac, from 1953 to 1995 small-caps outperformed large-caps in January 40 out of 43 years. But after the crash of 1987, this out-performance from the small-caps started to get going in mid-December. Perhaps it was no longer a secret? Who knows. But now this market is taking it step further. Last year in 2012, the small-cap out-performance began in mid-November. The ratio bottomed out on November 15th and rallied all the way into mid-March. So with all that in mind, is it so ridiculous to start talking about it this early?

Here is a chart I posted a year ago showing the seasonal trends of small-caps vs large caps. It shows the Russell2000 divided by the Russell1000 based on daily data from July 1, 1979 through November 30, 2012:

Just something to keep in mind while we plan what we’re going to do heading into the end of the year.
Please share this article