Small-Cap Effect (Small Cap Sector)
ByLarge companies (large caps) have been outperforming in the stock market recently, but that might all change very shortly. Small companies (small caps) have on average outperformed from December 19th to March 7th. From 1979/80 to 2008/09, the Russell 2000, the venerable index of small companies in the stock market, has produced a return of 5.4% during its seasonally strong period. This compares with a return of 2.1% for the Russell 1000 (large cap index) during the same time period.
The Small Cap Effect is a modified January Effect strategy, which is one of the most researched seasonal anomalies in the stock market. This traditional strategy is based upon small companies outperforming in the month of January because of tax loss selling in December.
The premise of this strategy is that investors sell their small caps in December to generate losses in order to offset any capital gains that they created during the year. Investors are more likely to sell their small companies that are trading at a loss, rather than their large companies
because they typically see their large companies as longterm holdings. The net result is small company stocks are often beaten down in price and end up representing good value for an astute investor.
This strategy has worked well, but the entry date has shifted from December 31st to December 19th. The shift has been caused by the popularity of the strategy. As more and more investors have tried to capitalize on this strategy, the date has shifted. Seasonal investors take advantage of the “earlier” January Effect by getting into the sector before the other investors who are still operating under the old paradigm of the trade starting at the beginning of January.
