Seasonal tendencies for the U.S. stock market between now and the end of the year will favor large-cap stocks over small caps.
Small-cap underperformance is likely to continue for several more months due to the compensation incentives under which institutional investors operate. Many managers will receive a year-end bonus if they finish the year ahead of the S&P 500. So as Dec. 31 gets nearer, they have a powerful incentive to start making their portfolios look increasingly like the S&P 500 — thereby locking in positive year-to-date outperformance.
“ Once January rolls around, institutional investors’ compensation incentives shift in the small-caps’ favor. ” The accompanying chart shows that stock market history accords nicely with the professors’ theory. Since 1926 small-cap relative strength, which is highest in January, declines steadily as the year progresses.