S&P 500 - Don't short company just announced for inclusion
Hate to cite such an "authoritative" source as USA Today, but the article illustrates why you don't want to be caught short on a stock that just gets included on the S&P 500 or caught long on momo of one whose inclusion on the S&P 500 is "old" news:
usatoday.com
'S&P effect' grows stronger But for individuals, chasing quick profit can be risky
By Adam Shell
USA TODAY
NEW YORK -- Nothing gives a stock a shot of adrenaline quite like news that it's being added to the Standard & Poor's 500-stock index. And this year, the so-called S&P effect is proving even more powerful.
Just ask giddy shareholders of handheld computer maker Palm and fiber-optics company JDS Uniphase. After Thursday's close, the S&P said it would add Palm to the benchmark July 27. Friday, Palm shares shot up 4% while the rest of the market tanked. Thursday, JDS Uniphase shares soared 20% after S&P said it would add JDS July 26.
From 1990 to 1999, stocks added to the S&P 500 have outperformed the index by an average of 7.8% between the time of the announcement and the day they're added, says Merrill Lynch. This year, the outperformance has been greater. Stocks added through June shot up 7% in just the day after the announcement and 12.7% by the time they were added.
Here's how the S&P effect works:
* S&P announces that a stock will be added to the 500-stock index. So far this year, 28 have been added, vs. 41 stocks last year.
* Momentum investors load up on the stock immediately because they know there will be pent-up demand. The reason: Index funds must buy the stock when the company joins the index, which usually occurs a week later. Merrill Lynch estimates that $800 billion is benchmarked against the S&P 500, up from $675 billion a year ago. That growth is a key reason the effect is more powerful this year.
* Those same momentum investors sell the inflated shares to index fund managers near the close of trading the day the stock is added to the index.
''Essentially, traders know there will be billions of dollars chasing the stock,'' says Diane Garnick, equity derivatives strategist at Merrill Lynch. ''It's a momentum trade.''
Profits usually follow -- at least in the short term. But there's a problem: The outperformance doesn't last long. Merrill found the stocks ''underperformed'' the S&P 500 for as many as 30 days after being added. Stocks added in 2000 lagged an average of 8% a month later.
Once index funds finish purchasing their shares, demand diminishes, stock prices retreat, and the index effect subsides. At that point, stocks again start trading on fundamentals, says Kris Culp, manager of index funds at T. Rowe Price.
''People think they can trade and profit on the news, but it's hard to make money unless you own the stock before it's added to the index,'' Culp says.
Investors who rush to buy shares when S&P announces an addition risk getting in late and buying shares at their peak, she says.
Gus Sauter, head of index funds at Vanguard Group, says investors can also get burned by buying the stock on the day it joins the index. ''Common wisdom says these stocks get bid up to the sky and close at their peak,'' he says.
That's not always the case. When CIT Group was added on July 14, the stock closed at $19.50 after trading as high as $20.63.
Still want to play the game? Garnick says your best chance of success is pinpointing stocks that are likely additions to the S&P 500 -- and buy them now. The best place to look? The biggest names in the S&P midcap index. ''Close to 80% of the additions have come from the S&P midcap index,'' she says.
She says Univision and Vitesse Semiconductor are likely candidates. Goldman Sachs, while not in the midcap, is also a good bet. |
