Small Cap Premium = January Effect?

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berntson
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Small Cap Premium = January Effect?

Post by berntson »

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This is a fascinating chart from Triumph of the Optimists: 101 Years of Global Investment Returns. Basically, without the January effect, small-cap stocks underperformed the rest of the market by .5% annually. The authors found no evidence for a January effect for large cap stocks. So it looks like basically, all of the outperformance of small caps in the US has historically come from a single month.

The data is now somewhat old (13 years), so it would be interesting to revisit the issue and see if it is still true that the small cap premium = January effect.

This somewhat reduces my credences that the small cap premium is a risk premium. Why would there be a risk premium that only pays investors in January? On the other hand, the authors point out that the small cap premium cannot be reduced to seasonal price changes internationally. I don't know what to make of this. But as a good Boglehead, I'll stay the course with my small caps!

I've also posted the chart for monthly returns for large caps below.

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pkcrafter
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Re: Small Cap Premium = January Effect?

Post by pkcrafter »

January effect--I think it's the newest F/F factor. :happy

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stevewolfe
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Re: Small Cap Premium = January Effect?

Post by stevewolfe »

pkcrafter wrote:January effect--I think it's the newest F/F factor. :happy

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Jebediah
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Re: Small Cap Premium = January Effect?

Post by Jebediah »

Here's a plot of SmB average by month, From French, 1927-present. (x axis is months 1-12).

Thing is, I think it's a similar story for all the factors.

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YDNAL
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Re: Small Cap Premium = January Effect?

Post by YDNAL »

berntson wrote:This is a fascinating chart from Triumph of the Optimists: 101 Years of Global Investment Returns. Basically, without the January effect, small-cap stocks underperformed the rest of the market by .5% annually. The authors found no evidence for a January effect for large cap stocks. So it looks like basically, all of the outperformance of small caps in the US has historically come from a single month.
Yes, it is the JAN factor but works best when incorporated with MAY factor and BAB factor.
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nisiprius
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Re: Small Cap Premium = January Effect?

Post by nisiprius »

Good grief.

I think it's the "million monkey" effect. If you set a million monkeys to work looking at financial data searching for bananas, given sufficiently long time, they would find a lot of bananas.
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momar
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Re: Small Cap Premium = January Effect?

Post by momar »

nisiprius wrote:Good grief.

I think it's the "million monkey" effect. If you set a million monkeys to work looking at financial data searching for bananas, given sufficiently long time, they would find a lot of bananas.
Do you know where they found all those bananas? I want to look there, too.
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IlliniDave
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Re: Small Cap Premium = January Effect?

Post by IlliniDave »

That's interesting. I expect in time it will get peanut-buttered throughout the calendar year as people seek to capture it.
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Clive
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Re: Small Cap Premium = January Effect?

Post by Clive »

Jebediah wrote:Here's a plot of SmB average by month, From French, 1927-present.
Doesn't French form an 'index' of stocks that fit the criteria once each year, and record the monthly gains of that set - which often contains fewer firms in the set each month. IIRC he records the number of firms as part of the dataset.

Looking at just the 'survivors', especially potentially highly volatile stocks, could see some taxation (or index) driven moves/changes at around the end/start of the tax year, and from a set comprised of just the winners rather than both winners and losers, a end of year distortion might (or appears to) arise.
rkhusky
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Re: Small Cap Premium = January Effect?

Post by rkhusky »

I looked at the FF 2x3 portfolios and if you look at different time periods the best months vary. Actually December looks better than January. In any case, the standard deviations ranges from 3-8%, most often quite larger than the average.
umfundi
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Re: Small Cap Premium = January Effect?

Post by umfundi »

nisiprius wrote:Good grief.

I think it's the "million monkey" effect. If you set a million monkeys to work looking at financial data searching for bananas, given sufficiently long time, they would find a lot of bananas.
It may be data mining at its finest, like the Super Bowl correlation that stopped working the moment it was identified. Except if you tilt to original teams, blah, blah. But, the Super Bowl correlation did not have a plausible explanation. (Did you know that butter production in Bangladesh is an excellent predictor of US stock prices?)

But here, the data is there, and all you have to do is construct a plausible explanation. There are already some suggestions in the thread. Or, "Investors tend to review their portfolios at year's end, and make trades in January. Generally, their decision is to dump larger companies in favor of smaller ones, to exploit the documented small-cap anomaly."

Then, make a prediction during December for relative small-cap gains in January. If you are wrong, everyone will forget. If you are right, you will be set as a pundit on CNBC for life. :P

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Jebediah
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Re: Small Cap Premium = January Effect?

Post by Jebediah »

If the data holds up, why would it be any less of a bona-fide anomaly than say, momentum?
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