November marks the start of the best six-month period in which to be long equities and as the 11th month of the year draws to a close, market participants increasingly ponder the odds of a Santa Claus rally and the arrival of the January Effect.
The January Effect is the notion that small-caps lead the market higher in January, setting the table for a positive performance by equities for the year. Thing is the January Effect has been starting earlier and earlier, so investors should consider mulling exchange traded funds such as the iShares Russell 2000 ETF (NYSE:IWM) before we get too deep into December.
IWM, the largest small-cap ETF by assets, came into Wednesday with a modest year-to-date loss while the S&P 500 entered the day with a 3.3 percent gain for the year. The headwinds faced by IWM have been legitimate. For example, the ETF's nearly 16 percent weight to health care stocks made it vulnerable to the summer biotech swoon. Additionally, some of IWM's financial services holdings are seen as vulnerable to higher interest rates. Financial services is IWM's largest sector weight at nearly 26 percent.
Still, IWM's potent seasonality is hard to ignore.
"US small-cap stocks have had a positive return between November 20 (or closest market day close) and year-end in 18 of the last 20 years. US large-cap stocks have also had great success at year end, also showing a positive return in 18 of the last 20 years," said index provider FTSE Russell in a note. "Yet the 'Santa Claus Effect' has been more pronounced in small caps versus large caps, with the Russell 2000 averaging a 5.6% increase between November 20 and year-end over the last 20 years compared to a 3.4% average increase in the Russell 1000 over the same time period."
Investors appear to be acknowledging that IWM's seasonality is legitimate. More than $2 billion in month-to-date inflows suggest as much. Some traders have also been consistently betting on the Direxion Daily Small Cap Bull 3X Shares (NYSE:TNA).
TNA, which attempts to deliver triple the daily performance of the Russell 2000, has seen average daily creation activity of nearly $1.8 million for the 30-day period ending Nov. 24, according to Direxion data.
"We've seen small caps underperform large caps in the US thus far in 2015, yet historical returns point to some very powerful seasonal trends. Traders or investors who want to take advantage of a perceived Santa Claus effect for US small caps between now and year-end may be considering a variety of approaches including using index-based options," said Russell Rhoads of the CBOE Options Institute in the FTSE Russell note.
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