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Sept. 11, 2021, 9:58 a.m. EDT

You ought to favor large-cap stocks through the end of the year

By Mark Hulbert

Small-cap stocks are likely to lag behind the broader market until the end of the year.

That’s because of seasonal tendencies that favor small-caps at the beginning of the year and large-caps at the end of the year. That information may help you if you’re choosing among companies of different sizes.

The accompanying chart, below, summarizes these seasonal tendencies, based on data back to 1926 (courtesy of Dartmouth professor Ken French). Notice that, on average over the past century, small-caps have beaten large-caps by the greatest amount in January. Beginning in February and continuing through the end of the year, the small-cap advantage steadily shrinks and by the fourth quarter is actually negative.

The data in the chart reflect historical averages, and needless to say not every year lives up to the long-term pattern.

This year is consistent with that pattern, as small-cap relative strength has steadily declined since January. (For the table I relied on the relative returns of the iShares Micro-Cap ETF (PSE:IWC) and the SPDR S&P 500 ETF (PSE:SPY) . I had to turn to those two ETFs to measure the small-cap advantage because French’s data extend only through June 30.)

Month Small-cap performance (IWC minus SPY)
January 15.1 percentage points
February-March 3.6 percentage points
April-June Minus 4.2 percentage points
Since July 1 Minus 8.7 percentage points

Strong as this pattern has been historically, however, investors should not bet on it continuing unless there is a plausible theory for why it should exist. In this case, however, there is such an explanation. Two, in fact.

The first, according to some researchers, is that this seasonal pattern traces to the compensation incentives under which institutional money managers operate. Because of those incentives, managers increasingly shift their portfolios as the year progresses so that they more closely match the S&P 500. In other words, they tend to favor small-caps earlier in the year and large-caps later in the year.

A full discussion of this hypothesis is beyond the scope of this column; interested readers are directed to a study that appeared more than a decade ago in the Journal of Business Finance & Accounting. Titled “Institutional Investors, Analyst Following, and the January Anomaly,” the study was conducted by Lucy Ackert, a professor of economics, finance and quantitative analysis at Kennesaw State University, and George Athanassakos, a professor of finance at the University of Western Ontario’s Ivey Business School.

The second hypothesis that some researchers have suggested is tax-loss selling, which has a disproportionate impact on the smallest stocks. Such selling must be completed no later than Dec. 31. So the smallest stocks will have the greatest downside pressure near the end of the year, and once that pressure is lifted in January, those stocks bounce back.

List of favored large-cap stocks

But which large-cap stocks tend to do well?

Regardless of the relative importance of those two hypotheses, these historical precedents suggest that you might want to favor large-cap stocks over small-cap for year-end trades.

With that in mind, I constructed a list of the 20 largest -cap stocks within the S&P 500 that are also recommended by two or more of the top-performing newsletters monitored by the Hulbert Financial Digest.

Stock Market-capitalization rank in S&P 500 Index Number of newsletters recommending the stock
Apple Inc. (NAS:AAPL) 1 4
Microsoft Corp. (NAS:MSFT) 2 2
Alphabet Inc. Class A (NAS:GOOGL) 3 2
Amazon.com Inc. (NAS:AMZN) 4 2
Facebook Inc. Class A (NAS:FB) 5 3
JPMorgan Chase & Co. (NYS:JPM) 10 3
Johnson & Johnson (NYS:JNJ) 11 2
Procter & Gamble Co. (NYS:PG) 14 2
Home Depot Inc. (NYS:HD) 15 2
Bank of America Corp. (NYS:BAC) 17 2
Walt Disney Co. (NYS:DIS) 18 3

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com .

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