Stocks Rally Again on First Day of Month, With Small Caps Leading

(Bloomberg) -- In the pandemic world, nobody relies too much on historic precedent. Things change too quickly. And yet one pattern that has endured is the equity market's weird habit of rising whenever the calendar flips.

As usual, stocks are up on the first trading day of a month, led by small caps. The Russell 2000 Index has done this 10 of 12 times this year, rising an average of 1.5%. That compares with a gain of 0.1% on any randomly chosen day. 

It's a rare thing that has managed to stick in a year of twists. Jerome Powell just scrapped a long-held view on inflation being transitory. Retail sales are booming as consumer confidence falls. November is usually a good month for equities -- this year's was the worst in more than a decade.  

“When we begin a new month, it's like you have a clean slate and a clean slate tends to see rotations back into the laggards in an asset-allocation model,” said Art Hogan, chief markets strategist at National Securities. “You've got a cohort of investors that say, ‘OK, where are we out of balance here on this asset-allocation?' And oftentimes that's the laggard Russell 2000, the laggard small-caps, the laggard values.”

The small-cap index, which ended last month at the edge of a correction, rallied more than 2% Wednesday, poised for the biggest gain since November's first day. Its 83% success rate of rising to start the month in 2021 compares with 56% in the previous four decades, data compiled by Bloomberg show. 

Read: Reflation Trades Always Seem to Take Off When the Month Flips

Why this has been happening is by no means clear, though theories exist. One is that retail investors who have flocked to stocks since the 2020 pandemic trough could be allocating their 401k/retirement on a monthly basis. 

“When you have new money to put to work, as is typical on the first day of each month, investors look to take advantage of longer term themes,” said J.C. O'Hara, chief market technician at MKM Partners LLC.

Another explanation ties the propensity, roughly mirrored in other economically sensitive companies, to institutional funds allocating money into strong-conviction bets in anticipation of bullish economic news.

Loosely, the gains come right around the time the Institute for Supply Management's gauge of factory activity comes out, and Wednesday's report showed manufacturing advanced in November as new orders accelerated and factories ramped up production and hiring.

It could also be driven by investment pros looking for excess returns to boost year-end results.

“Active managers are behind by and large this year,” Cliff Hodge, chief investment officer at Cornerstone Wealth Group, said by phone. “So there's certainly some pressure to add beta and add exposures to things that could work a little bit better than index.”

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