Since the FTSE small-cap index was launched in 1986, it has returned an average of 1.88 per cent per month in the winter months (November to April) but lost an average of 0.35 per cent per month between May and October. This contradicts both economic theory and common sense. These tell us that risk should bring rewards. But for half of the time this is not true and risky small caps actually lose us money.
This seasonality is greater than the seasonality of the All-Share index. The difference in returns between winter and summer has been 2.23 per cent per month. But during this time it has been only (only!) 1.32 per cent per month for the All-Share, with winter returns of 1.56 per cent per month and summer returns of 0.24 per cent per month.
You might think the greater seasonality of small caps is because they are high-beta stocks - very sensitive to moves in the All-Share - and so do especially well in good times and badly in bad times.
You'd be wrong. A look at returns in individual months shows why. It shows that small caps underperform the All-Share in the last four months of the year. In October and November they fall even though the All-Share rises, which is inconsistent with the idea that they have a high beta. But small caps outperform at the start of the year and in April and May.
| Average monthly returns since January 1986 | ||
| All-Share | Small caps | |
| January | 0.74 | 3.05 |
| February | 1.35 | 2.42 |
| March | 1.28 | 0.82 |
| April | 2.27 | 3.56 |
| May | 0.77 | 1.20 |
| June | -0.51 | 0.63 |
| July | 1.08 | -0.24 |
| August | 0.49 | 0.68 |
| September | -0.94 | -1.85 |
| October | 0.57 | -1.25 |
| November | 0.80 | -0.14 |
| December | 2.94 | 1.58 |
| Total returns. Small caps exclude investment trusts | ||
I suspect there are two things going on here. One is a 'new year, new hope' effect. At the turn of the year, investors look ahead to better times - they really do forget auld acquaintance - and this gives neglected small caps a lift.
Second, small caps are more sensitive to changes in moods caused by changes in daylight. As the nights get shorter in the autumn, people become more anxious and depressed, and this hurts small stocks more than bigger ones. And as the nights get shorter, optimism increases, which causes small caps to do especially well in the spring. So well, in fact, that they become overpriced and so fall back in the summer.
There are two messages here. One is that if history is any guide - and personally I trust it more than futurology - now is no time to increase exposure to small stocks.
The other is that small caps are more sensitive to sentiment than big stocks are. And this suggests they might be more often mispriced - both upwards and downwards - than larger stocks. In this sense, there is a case for stock-pickers to focus their attentions upon smaller caps, at least in the winter.
