Implications of the NDX rebalancing match our contrarian philosophy
In the latest annual reconstitution of the Nasdaq-100 Index (NDX), six companies earned their spot in the index, while six others bid farewell. The tables below shows the year-to-date returns for each of those stocks, in addition to brokerage buy/sell data from Zacks.
In the subsequent analysis, I will compare the performance of newly added stocks and those that bid adieu during this annual reshuffling. The objective is to discern whether this dynamic can serve as a meaningful indicator for future stock returns.
Additions vs. Removals
I tracked 77 stocks that were added to the NDX and 62 that were removed since 2010. We don’t have data on some removed stocks that are no longer trading. I am also only considering stocks that were added and removed in December during the annual NDX rebalancing, and not those that joined or left the index 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, especially in shorter-term timeframes. Stocks added to the index in December averaged a return of 3.21% over the next three months, compared to an 8.4% gain for those removed.
Over the next three months, about 46% of stocks added beat the NDX, while 56% of the stocks removed beat the index. Looking at one year later, the stocks added to the index averaged a gain of about 13%, with 31% of the stocks beating the overall index. Those figures underperform compared to stocks removed from the index, which averaged a gain of 19% over the next year, with 46% of those stocks beating it.
I can identify a couple of factors that may contribute to the outperformance of stocks removed compared to those newly added. The initial announcement of stock additions tends to generate buying pressure from funds that replicate the index. This can propel the stock price beyond its fair value, resulting in subsequent underperformance.
For the stocks being removed, this scenario is reversed. Additionally, newly added stocks have often performed well and garnered significant market enthusiasm. It’s an indication of bullish sentiment, which has bearish implications based on our contrarian philosophy.
In the following table, I examine three-month returns for stocks after that were added and removed from the NDX. Stocks that were removed outpaced new additions in only six out of 13 years. Those removed, however, have beaten the joiners by a significant amount in each of the last three years.
In fact, when those removed have beaten those added, it has typically been by a substantial margin. That’s why the overall average return of the leavers has been superior to the joiners.
This last table shows how the stocks added did compared to those removed over the next 12 months. It’s broken down yearly since 2010. The stocks removed beat those added in nine of the past 13 years, including the last three years.
