2007/2008 January Effect

This year the January trade returned a negative 0.34% before transaction costs for the period from 12/20/2007 to 1/9/2008: chart. Microcaps continued the downtrend that started in Q2: 2007 IWC:SPY chart.

Emerging markets on the other hand, are off to a good start in 2008 continuing a long-term uptrend vs. the US markets that started in 2000: here's a chart from 2005.

2007 Demo Portfolio Results (Revisited)

The Demo portfolio finished 2007 with a return of 17.62% net of transaction costs, for the 9 months from 4/1/2007 to 12/31/2007, well above the 9.63% benchmark results. I will continue trading the same model in 2008 and will keep the short model allocation to around 20-25% of the NAV to reduce portfolio risk.

The short model started trading at the end of August and so far has met my expectations despite a 145% loss in TMTA in October. Given the low capitalization of the stocks selected by the model, the risk of another TMTA going forward is high, but the simulation includes these jumps in the backtested results*.

*I checked the simulation log from 2/24/2003 to 1/7/2008 and found a total of 251 transactions for this 4.8 years period, averaging 47 calendar days holding period p/position or around 7 stocks per week. Contrary to what I thought initially, the highest simulated loss is only 35% for OPWV on 1/12/2004. Interestingly, OPWV is currently my best position carrying a 60% positive return from 8/2007.

This is a complete log of the highest simulated losses:

Symbol	Open	Close	Days	Pct
OPWV	12/29/2003	1/12/2004	14	35.40%
MDTL	9/17/2007	10/1/2007	14	33.76%
PRSF	12/22/2003	1/26/2004	35	27.44%
SSRI	1/18/2005	2/14/2005	27	25.23%
COSI	6/6/2005	6/13/2005	7	23.77%
MONE	7/26/2004	8/2/2004	7	22.28%
PRSF	12/22/2003	2/2/2004	42	22.26%
SYNM	11/7/2005	11/28/2005	21	21.44%
INPC	3/20/2006	4/10/2006	21	20.79%
MENT	12/29/2003	1/12/2004	14	20.24%

January Effect

Ho, ho, ho, it's that time of the year... The city is shining with lights and colors, shoppers are flocking to the stores and investors are learning about the January effect. A strategy going long micro-cap stocks while simultaneously shorting an equivalent dollar amount based on the S&P500 future has been positive for 22 of the past 24 years: Mark Hulbert. Wikipedia.

One of the reason that explains this calendar effect is tax-loss selling. In December investors tend to dump their portfolio losers to take advantage of the tax cut. In January the selling pressure abates giving a boost to micro-cap stocks. Why micro-cap stocks in particular? Because lower liquid stocks have a higher chance to suffer from the December selling pressure than large-cap stocks. Also micro-caps tend to be more volatile and thus are the best candidates in December.

Today every folk on Wall St. and his mom knows about the January Effect and yet the strategy continues to deliver, including the last trade in 2006-2007. The reason is that it's actually hard to exploit this inefficiency with substantial capital due to the lack of leveraged instruments and liquidity in micro-cap stocks. But for the average investor there is still a chance to go long IWC (Micro-Cap ETF) and short SPY, or QQQQ.

I run the strategy on Hudson using SPY for the short leg and going long DFSCX, a micro-cap fund. All data is available for free from Yahoo for the last 11 years. After several runs I found the optimal period in terms of risk-adjusted returns from Dec-20 to Jan-9:
Records: 2797
Period: [1996-Jun-20/2007-Jul-31]
Total days: 4059
Hedge Records: 6961
Hedge Period: [1980-Jan-02/2007-Jul-31]
Hedge Total days: 10073

Trade results
--
Trades: 11
Avg trade: 2.37%
Std dev: 2.41%
Skew: -43.92
2SD Range: -2.45% | 7.18%
3SD Range: -4.86% | 9.59%
Pos trades: 9 (81.82%)
Neg trades: 2 (18.18%)
Avg pos: 3.21%
Avg neg: -1.42%
Best: 5.65% [1999-Dec-20/1999-Dec-20]
Worst: -2.29% [2004-Dec-20/2004-Dec-20]
Max cons pos: 6 [1996-Dec-20/2001-Dec-20]
Max cons neg: 1 [2002-Dec-20/2002-Dec-20]
Max drawdown: -2.29% [2004-Dec-20/2004-Dec-20]