It’s that time of year again — the annual rebalancing of the Nasdaq-100 Index (NDX). The NDX represents the 100 largest non-financial companies listed on the Nasdaq stock exchange. On Monday, three new companies were added to the index, and three others were removed.
When a stock is included in a widely followed index, it often generates demand from exchange-traded funds (ETFs) and index funds, while removal typically leads to selling pressure. These changes were announced about a couple weeks ago, meaning much of the buying and selling has already occurred.
This week, I’m examining what happens once these stocks begin trading in the index. One theory is that the announcement of additions and removals can shift sentiment, and if the initial buying or selling overshoots, it can create opportunities going forward. Before diving into the historical data, the tables below show the stocks that were added as well as those removed.
Goin back to 2010, I tracked 80 stocks added to the NDX and 73 removed. We don’t have data on some of the stocks that aren’t trading anymore. I am also only considering stocks added and removed in December during the rebalancing. I will not be considering stocks eliminated and added mid-year due to bankruptcy, mergers, etc.
The tables below summarize the returns of the stocks added and removed since 2010. The stocks that were removed performed better than those added. Stocks added to the index in December averaged a return of 3.81% over the next three months, compared to a 7.27% gain for those removed.
Over the next three months, less than half the stocks added beat NDX, but 56% of those removed beat the NDX. One year later, the stocks added to the index averaged a gain of about 12%, with 40% of the stocks beating the overall index. Those figures underperform compared to stocks removed from the index, which averaged a pop of 18% over the next year, with 52% of those stocks beating the NDX. Based on these numbers, there could be merit to the theory that sentiment tends to get too bullish for those added, and too bearish for those removed.
Next, I incorporated analyst ratings to identify stocks with extreme sentiment. Stocks added to the index are prone to excessive bullish sentiment. Using my historical data, I focused on stocks added that had at least 80% of analysts recommending a “buy” on the day they were added. This may be an indicator of sentiment being too bullish.
Conversely, stocks removed from the index can attract excessive bearish sentiment. I analyzed stocks removed with 20% or fewer firms sporting a “buy” rating. If this theory holds, stocks added with bullish sentiment may underperform, while those removed with bearish sentiment may outperform.
