Simple Market Capitalization Concentration Trading Strategy

“Market Capitalization Concentration as Stock Market Predictor” summarizes research finding that the change in the level of concentration of total market capitalization in the largest firms may be a useful predictor of stock market returns. Does a simple trading strategy based on this finding beat the market? To investigate, we examine the ratio of the S&P 500 Index (representing large stocks) and the Russell 2000 Index (representing small stocks). When the concentration of total market capitalization in large firms is high (low), this ratio is high (low). In concert with the referenced research, we derive trading signals from the lagged annual change in this index ratio. Using monthly levels of the S&P 500 Index, the Russell 2000 Index and the monthly yield on 13-week Treasury bills (T-bills) from inception of the Russell 2000 Index in September 1987 through September 2012, we find that: (more…)