The Nasdaq-100 Index (NDX), a benchmark of the 100 largest non-financial companies listed on the Nasdaq exchange, undergoes an annual rebalancing. This year, three new companies joined the ranks, while three were removed. This event often triggers significant trading activity as Exchange Traded Funds (ETFs) and index funds adjust their holdings to reflect the changes. While the initial buying and selling pressure typically occurs before the official rebalancing date, understanding the historical performance of added and removed stocks can offer valuable insights for investors.
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Analyzing Historical Performance of Added and Removed Stocks
To gain a deeper understanding of post-rebalancing performance, we examined historical data dating back to 2010, focusing specifically on December rebalancing events. This analysis excludes mid-year adjustments due to events like bankruptcies or mergers. Our dataset encompasses 80 added stocks and 73 removed stocks, providing a robust sample size for identifying potential trends.
Historically, removed stocks have outperformed added stocks in the three months following the rebalancing. Removed stocks averaged a 7.27% return compared to a 3.81% return for added stocks. This trend continues over a one-year horizon, with removed stocks averaging an 18% gain versus a 12% gain for added stocks. Furthermore, a larger percentage of removed stocks outperformed the NDX compared to added stocks, both in the three-month and one-year periods.
Identifying Sentiment Extremes and Potential Mispricing
The disparity in performance between added and removed stocks suggests the possibility of sentiment overshoots. To explore this further, we incorporated analyst ratings into our analysis. We examined stocks added to the index with at least 80% “buy” recommendations, indicating potentially excessive bullish sentiment. Conversely, we looked at removed stocks with 20% or fewer “buy” ratings, suggesting overly bearish sentiment.
Our findings reveal a compelling pattern. Removed stocks with bearish sentiment (20% or fewer “buy” ratings) significantly outperformed the market, averaging a 34% gain over the following year, with 58% surpassing the NDX. This suggests potential buying opportunities in stocks like Moderna (MRNA) and Super Micro Computer (SMCI), which were removed this year and exhibit bearish sentiment.
In contrast, added stocks with bullish sentiment (80% or more “buy” ratings) underperformed, averaging a gain of less than 5% in the subsequent year, with only 22% outpacing the NDX. This highlights the risk of overpaying for stocks driven by excessive optimism. Axon Enterprise (AXON), added this year with unanimous “buy” ratings, exemplifies this potential for underperformance.
Conclusion: Leveraging Historical Insights for Investment Decisions
The annual Nasdaq-100 rebalancing presents unique investment opportunities. By analyzing historical trends and incorporating sentiment indicators like analyst ratings, investors can potentially identify mispriced stocks. Our analysis suggests that removed stocks with bearish sentiment and added stocks with excessive bullish sentiment warrant particular attention. This framework can empower investors to navigate the complexities of the market and make more informed investment decisions. While past performance is not indicative of future results, understanding historical patterns can provide a valuable edge in the dynamic world of finance.
