It’s the time of year when consumers of financial media will hear numerous references to “window dressing” as it relates to Oct. 31 — the date on which many mutual funds close out their fiscal years.
The conventional wisdom holds that as the end of the fiscal year approaches, funds will dump underperformers to lock in tax losses and get losing names out of the portfolio report that gets mailed out to investors.
But is this October effect for real?
A look at some recent data shows that it is, but it indicates something else, too: These window dressing victims also are a dangerous place to bargain-hunt in November.
This table shows the performance of some notable large- and mid-cap laggards around Oct. 31 during the past three years, and in 2006 and 2007.* A look at the table reveals that stocks which had underperformed the broader market by a wide margin in the year-to-date period through Sept. 30 indeed continued to lag by a wide margin during October. While the S&P 500 averaged a return of 3.46% in the five Octobers measured, the underperformers registered a loss of 1.53%.
There were a few cases in which the laggards turned around and rallied hard in October — such as Akamai Technologies (NASDAQ:AKAM) and F5 Networks (NASDAQ:FFIV) last year — but on 34 of 50 occasions, they continued to trail the index.
This obviously isn’t definitive evidence because of the small sample size, but it does indicate that the conventional wisdom is true: October is in fact a dangerous time to go bottom-fishing.
This makes sense intuitively given the behavior of institutional investors surrounding their fiscal year-end, but the real surprise is that stocks hit by October selling don’t necessarily rebound in November. It would seem that they should, since the selling pressure related to the fiscal-year end is removed at that point. However, the data show that this group of stocks actually performed worse in November than they had in the previous month: an average return of -5.51%, compared with 0.77 for the S&P 500 — a gap of 6.3 percentage points. On 36 of 50 occasions, the stocks underperformed the index.
The takeaway: Stocks that are subject to selling related to window dressing might be just as dangerous after Oct. 31 has passed.
With that said, here’s a look at some big-name stocks that could be in the danger zone here based on their year-to-date underperformance:
|Advanced Micro Devices||AMD||-48.5%|
|ITT Educational Services||ESI||-48.4%|
|Abercrombie & Fitch||ANF||-32.4%|
* For the purposes of this analysis, 2008 was thrown out due to the extreme volatility surrounding the financial crisis that autumn.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.