Turn of the Year and Size in U.S. Equities

The turn of the year (December-January) for the U.S. stock market reportedly includes the Santa Claus rally and the January effect. Some research indicates the latter is dead (and was driven essentially by small-capitalization stocks when alive). How does the stock market behave across the turn of the year for a recent sample? To check, we construct cumulative return profiles from 20 trading days before through 20 trading days after the end of the calendar year for the Russell 2000 Index, the S&P 500 Index and the Dow Jones Industrial Average (DJIA) since the inception of the Russell 2000 Index. Using daily and monthly levels of all three indexes from December 1987 through January 2012 (25 December and 25 January observations), we find that:

The following chart compares cumulative return profiles for the Russell 2000 Index, the S&P 500 Index and DJIA from 20 trading days before through 20 trading days after the turn of the year over the entire sample period. The dashed vertical line marks the end of the calendar year. Results suggest that:

• There is a Santa Clause rally from about ten trading days before to three trading days after the turn of the year. The rally is stronger for small-capitalization stocks than for large-capitalization stocks.
• While small stocks beat large stocks in January, January tends to be flat to weak rather than strong. Investors may in recent years have sought to exploit the reported January effect by moving early, especially into small-capitalization stocks, thereby killing the effect.

However, given the variability of returns, sample size is small for inference.

As a check on pattern robustness, we look at subperiods.

The next two charts compare cumulative return profiles for the Russell 2000 Index, the S&P 500 Index and DJIA from 20 trading days before through 20 trading days after the turn of the year during the first half (upper chart) and second half (lower chart) of the sample period. Again, the dashed vertical lines mark the end of the calendar year. Differences between the two charts suggest that:

• The January effect has disappeared, if not reversed.
• The Santa Claus rally has compressed in duration and magnitude.
• Small stocks still generally outperform large stocks.

Subsample sizes are very small for inference.

For a different perspective, we look at average monthly returns.

The final chart compares average December returns and average January returns for the three indexes over the entire sample period. Results generally confirm those in the first chart above. January is not especially strong, and the difference between returns on small stocks and large stocks is small during January (but not during December).

Again, sample size is small.

In summary, evidence from simple tests on recent data sets suggests that there is a compressing Santa Claus rally, there is no January effect, and there may be an exploitable divergence in the behaviors of small-capitalization and large-capitalization stocks concentrated in late December.

Cautions regarding findings include:

• As noted, sample/subsample sizes are small.
• Reported returns are gross. Any trading frictions incurred in exploitation would reduce them.
• These indexes ignore dividends and do not reflect any costs of turning them into tradable assets.

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