Factor Returns: Year-End Calendar Effects

Momentum in December versus Value & Size in January?

December 2017. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Value & Size generate abnormally large positive returns in January, Momentum negative returns
  • Abnormal returns are limited to the last week of December and first week of January
  • Difficult to harvest these returns efficiently due to illiquidity of markets at these times

INTRODUCTION

At this time of the year investors tend to receive market outlooks for 2018 from a variety of service providers. These can be used by investors to contrast their own views and ultimately position their portfolios. The long-term returns for equities, bonds and real estate are unlikely to be attractive given high valuations from years of quantitative easing by the world’s central banks. However, economies around the globe are showing healthy growth and perhaps the next few years will continue to generate positive returns for investors. Aside from strategic allocation questions, investors can also consider more short-term tactical allocations. Factor returns are known to be influenced by year-end calendar effects, which can potentially be exploited over the next few weeks. In this short research note we will analyse factor returns and year-end calendar effects from a tactical trading perspective.

METHODOLOGY

We focus on Value, Size and Momentum and use Fama-French data, which is available for the US from 1926 to 2017 and for international markets from 1990 to 2017. Portfolios are created by taking the top and bottom 10% of the US stock market and top and bottom 30% in other markets. The long-short portfolios are dollar-neutral and exclude transaction costs (read Factor Construction: Beta vs $-Neutrality).

CALENDAR EFFECTS IN THE US

The chart below shows the daily excess returns for the Value, Size and Momentum factors for the period from 1926 to 2016. The analysis highlights that the returns in December were abnormally negative for Size and abnormally positive for Momentum. In January we can observe a reversal and the returns were abnormally large for Value and Size while abnormally negative for Momentum. There are several theories explaining these unusual return distributions; two key ones being w