January and its Effects - Style Rotation - Small Cap Outperformance

The January Effect ... In December

• The S&P 600 Small Cap Index [SML] has outperformed the S&P 500 Large Cap Index [SPX] in material fashion thus far in 2010, by a score of +22% to +10%, respectively, in fact. (Data thru 12/8/10)
• Traditionally, the period of time from late-September to Mid-December offers outperformance from Large Cap stocks, a generality that has failed to show itself in 2010. Since September 30th, the S&P 600 [SML] has gained 13%, versus the 8% gain in SPX.
• Conversely, the period of time from mid-December until March of the following year encompasses one of the strongest examples of style rotation within the market. Historically this phenomenon was referred to as the "January Effect," despite the fact that it is truly observed to begin by mid-December. Nonetheless, the "January Effect" refers to the dynamic performance of Small Cap stocks that often begins around this time of year.
• According to Stock Trader's Almanac, which uses a comparison of the Russell 1000 Large Cap Index [RUI] vs. Russell 2000 Small Cap Index [RUT] to make their point, the following average rates of return have existed since 1979:
  31-Yr Average Rates of Return (Dec. 1979 - Feb. 2010)

  12/15 - 12/31
  RUI: 1.6%
  RUT: 3.1%
  

  12/15 - 2/28
  RUI: 2.5%
  RUT: 5.7%
  

  Notice both that Small Caps, on average, double the return of Large Caps from mid-December until the end of February, and that the trend is already well underway by the time January rolls around. To put the margin of outperformance into perspective, just the spread between Small and Large cap Indexes accounts for a return of nearly 20% on an annualized basis, clearly well above the long-term average annual unhedged returns for the market.

  Source: Stock Traders Almanac 2011, pg. 102