'December Effect' Bodes Well for Hedge Funds, Equities

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 |  Includes: DIA, QQQ, SPY
by: FINalternatives

Hedge fund advisory firm the Hennessee Group believes the equity markets are likely to continue their momentum and lead to additional gains for investors during the month of December.

“We believe the December Effect, whereby investors choose to defer paying taxes on equity market gains until the following year, will provide additional support to the equity markets as we close out the year,” said Charles Gradante, co-founder of the Hennessee Group. “And historical data seems to support this thesis as the equity markets have experienced gains during the final month of the year 70% of the time when positive through the month of November.” Additionally, says Gradante, hedge funds have experienced gains in December 100% of the time during the same calendar year periods.

The December Effect: Equity Markets And Hedge Funds

The Hennessee Group recently conducted a brief study examining the historical performance of the equity markets and hedge funds when entering the final month of the year with positive year-to-date gains. The study focused on the calendar year periods dating back to 1995; using the S&P 500 Index and the Hennessee Hedge Fund Index as proxies. As illustrated in the chart below, dating back to 1995, the S&P 500 Index has generated positive returns through November in 10 calendar year periods and experienced additional gains in December 70% of the time. In comparison, hedge funds managed to generate gains in nine of the calendar year periods the S&P 500 Index was positive through November and experienced gains in December 100% of the time.

YTD-Nov.

Dec. Only

Year S&P500 Hennessee Hedge Fund Index S&P500 Hennessee Hedge Fund Index
1995 31.82% 15.79% 1.74% 1.65%
1996 22.91% 17.67% -2.15% 1.20%
1997 28.98% 16.84% 1.57% 1.16%
1998 19.91% -0.28% 5.64% 1.70%
1999 12.97% 22.57% 5.78% 6.70%
2003 20.28% 16.75% 5.08% 1.76%
2004 5.57% 6.31% 3.25% 1.82%
2005 3.12% 6.10% -0.10% 1.66%
2006 12.23% 9.99% 1.26% 1.28%
2007 4.44% 10.85% -0.86% 0.33%
Positive 10 9 7 10
Click to enlarge

Note: Hedge funds experienced a challenging period in 1998 due in large part to the failure of Long-Term Capital Management.

"The data supports the December Effect Theory and bodes well for investors as we close out 2009. Hennessee Research indicates that when the equity markets were positive through November, they gained on average +2.1% in December while hedge funds gained +1.9%,” said Gradante.

Optimistic Hedge Fund Outlook For 2010

While the Hennessee Group is optimistic for both the equity markets and hedge funds heading into the final month of the year due to the December Effect, the firm is more optimistic that hedge funds are well positioned for a good year on a relative basis in 2010. According to Gradante, fundamentals will matter again in the coming year which should lead to an increase in dispersion between sectors and individual stocks, particularly as the rally gets long in the tooth.

In addition, he says, the equity markets are likely to trade in a range as opposed to trend in one particular direction in 2010. Gradante says such an environment should favor hedge funds relative to their traditional counterparts as they will have the opportunity to generate alpha on both the long and short side of their portfolios while not having to rely on market direction or beta for returns.