Subject: Re: OT: so you want an index
Jim wrote: If you do find yourself still long at a big pointy bear market bottom, whether it was a slow predictable bear or a sudden surprise plunge, as soon as you think the bottom is in it's a fabulous time to overweight small caps till about 14 months from the bottom.
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This is good advice... most of the time. There is a caveat. The amount of forward returns are very much tied to the degree of drawdown in the previous bear market.

Very much so. I did say "big" pointy bear market bottom, but I did not emphasize it. You're right. This is the sort of thing that might make sense only after a *major* market bottom. Very big fall. In recent decades, only the three times I mentioned.

And don't switch to small caps until good confirmation signs that the bottom has been seen. You don't really want to hold those small caps starting at a "false" bottom on the way down the bear.

What surprised me in this particular effect is the relatively longevity of the outperformance. 14 months is a nice stretch.
For example, the other well known rule of what to hold just after a major bottom is to buy the absolute worst junk that has fallen the most: the stuff you'd normally short. But that works for only a matter of weeks. If the small cap rule works for longer, it's that much easier to wait for really good confirmation after the bottom, you can take your time to make sure that you are climbing the second stroke of the "V".

Oddly enough I forgot to test 1987, so that's an out of sample validation of my "about 14 months" thesis. The big outperformance didn't last as long that time: 9 or 10 months would have been optimal in terms of total return. The 120 VL smallest caps beat S&P CAGR by 20-25% for 9-10 months. The top 60 of those small caps by ROE beat SPY by a CAGR of 39-47%. The aggregate advantage was still there at the 14 month mark but was eroding because the small caps were underperformers around months 10-14. (in fact steadily underperformers until from 10 to 38 months after the '87 bottom, end 1990).


Jim