Large-Caps in December, Small-Caps in January

MarketWatch’s Mark Hulbert says investors should think about focusing on large-cap stocks for the rest of the year, though it has nothing to do with the fiscal cliff or the aging of the bull market. Instead, it has to do with institutional money managers’ incentive structures. 

“Consider a money manager who, at the beginning of December, is ahead of the S&P for year-to-date performance,” Hulbert explains. “If he is like the majority of money managers whose performance bonus is based on outperforming that or a similar index, he will be under considerable pressure to lock in that lead by shifting his portfolio holdings away from small caps and in favor of holding the large-cap stocks that dominate the S&P 500.”

Managers who are behind the S&P, meanwhile, have another incentive not to stray too far from the index: “To avoid ending the year’s rankings at or near the bottom, which carries a considerable amount of career risk,” Hulbert says.

When January and the new year come around, however, managers start back at zero again, and are likely to up their risk-taking quite a bit. Hulbert provides data about the market’s historical returns for December, January, and the rest of the year to support this theory.