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This Month-End Market Anomaly Accounts For Nearly All Stock Returns

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It’s dangerous to get too enamored with data-mined results that could be a random fluke (there is a lot of data out there to mine) as easily as it could be a real anomaly with predictive value, but sometimes the trend just bowls you over.

“Since 1926, one could have held the S&P 500 index for only seven business days a month and pocketed almost the entire market return with forty percent lower volatility compared to a buy and hold strategy,” write Kalle Rinne, Matti Suominem, and Lauri Vaittinen in their recent paper Dash for Cash: Month-End Liquidity Needs and the Predictability of Stock Returns.

Month-End Market cumulative turn of month returns 1114

Month-end market anomaly: The mechanism behind a week of outsized returns

Pension funds, mutual funds, and anyone else liable for month-end distributions has to sell stocks at least three days in advance (T-3 in the paper) to make sure they have the necessary liquidity to make those payments, resulting in billions of dollars’ worth of liquidated positions that don’t actually represent a view on the market, causing prices to dip before T-3. Then from T-3 to T (the end of the month) the market recovers from that temporary selling pressure.

At the beginning of the month the exact opposite happens. Reinvestment from recently received dividends, pension payments, and other distributions create buying pressure that temporarily boosts prices with a small correction afterwards.

Month-End Market daily month end returns 1114

What’s striking isn’t that the selling pressure exists (this is similar to the opportunities created by year-end tax selling), but that it manages to capture virtually all market returns over the last 90 years with the rest of the month netting out to noise.

Individuals may have trouble capitalizing on this anomaly

But before you run off to set up your seven-day per month hedge fund, there are couple important things worth remembering. First, it’s the nature of systemic arbitrage to disappear. Keeping this in mind while you look for attractive entry points is reasonable, but not as a replacement for a well thought out investment strategy. Second, rebuilding your portfolio twice a month from scratch is going to rack up a lot of fees, and you lose out on the tax advantages of a buy-and-hold strategy.

Whether individual investors can really put this result to good use, it seems like a great opportunity for pension funds (which are forced to make these monthly adjustments anyways) to benefit from a fairly minor change. Virtually every pension makes payments on the first or last day of the month, but shifting that date a bit (as a few have done) gets them out of synch with their peers.

Month-End Market pension fund payments 1114

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