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

| | Posted in: Calendar Effects, Size Effect

Is there a reliable and material market capitalization (size) effect among U.S. stocks around the turn-of-the-year (TOTY)? To check, we track cumulative returns 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. We also look at full-month December and January returns for these indexes. Using daily and monthly levels of all three indexes during December 1987 through January 2020 (33 December and 33 January observations), we find that:

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

  • Stocks rally from about 10 trading days before through three trading days after TOTY. The rally is stronger for small-capitalization stocks than for large-capitalization stocks.
  • While small stocks modestly beat large stocks in January, January tends to be flat to weak.

While sample size is small for evaluation of annual anomalies, we look at subperiods as a robustness test.

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

  • The year-end rally is much smaller in magnitude during the second half, but small stocks still modestly outperform large stocks. Results suggest market adaptation to findings from the first half of the sample.
  • January becomes consistently negative on average during the second half for both small and large stocks.

Subsample sizes are very small for investigation of annual anomalies.

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

The next 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. On average, small stocks outperform large stocks during December. January is relatively weak, and the difference between returns on small stocks and large stocks is small during January.

Sample size is small for evaluation of annual anomalies.

For deeper insight, we look at Russell 2000 Index outperformance of the S&P 500 Index in December by year.

The final chart shows Russell 2000 Index return minus S&P 500 Index return during December of each year over the full sample period, along with a best-fit trend line. Small stocks beat big stocks in 20 of 33 years, but outperformance concentrates in a few years. During four of the last five years, small stocks substantially underperform.

The trend line slopes downward from left to right, suggesting disappearance of small stock outperformance, but the sample is small for trend analysis.

In summary, evidence from simple tests on recent data suggest that, while small stocks outperform large stocks on average during the second half of December, outperformance is fading and unreliable.

Cautions regarding findings include:

  • As noted, sample/subsample sizes are small for analysis of annual anomalies.
  • Reported returns are gross. Any trading frictions incurred in exploitation would reduce them.
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