knows that marine conditions are variable and unpredictable by nature, but Maury’s publication showed sailors how to use the oceans’ prevailing currents and winds to their advantage. From that point forward, the time required for sea travel was reduced dramatically, efficient trade routes were created and cross-continent commerce and immigration flourished.
In many ways, the world of investing resembles sailing on the high seas. From a day-to-day perspective, conditions can change rapidly. Gains made in the markets on one day can be quickly erased the next and seemingly calamitous storms can quickly transform into calmer waters. Historically, this variability and unpredictability has led investors to practice superstitions akin to those of a 1800s seaman:
The “October Effect” – Followers sell all of their stocks every October because the 1929 and 1987 stock market crashes both occurred in that specific month.
The “Super Bowl Theory” – Followers believe that if the National Football Conference team wins the Super Bowl, the stock market will go up, and vice versa.
The “Hemline Theory” – Followers believe that when higher hemlines are in style amongst women, the stock market will rise, and vice versa.
Fortunately for investors, the 1980s and 1990s brought tremendous academic advances in the world of investing, in 1981, Rolf Banz, then a professor at Northwestern University, published the first research documenting the fact that in general, companies with smaller market capitalizations (“small cap” companies) provided investors with greater returns than large-cap companies over long periods of time.1 His research showed that this “size effect” had been in existence for decades prior, yet like the nautical weather research of Maury described above, no one before him had compiled and presented the evidence to the world.