Bullish sentiment around freshly minted NDX stocks usually has bearish implications
During its annual reconstitution, the Nasdaq-100 Index (NDX) added six names, and removed seven. These stocks are listed below, alongside their year-to-date returns and some Zacks brokerage data. Let’s compare the returns of stocks added over the annual reconstitution to those removed, and see if that could serve as an indicator of what’s to come.
Additions vs. Removals
I tracked 71 stocks added to the NDX and 65 removed since 2010. We don’t have data on some of the removed stocks that aren’t trading anymore. I am also only considering stocks added and removed in December, over the annual reconstitution. I’m not taking into consideration stocks eliminated and added mid-year due to bankruptcy, mergers, etc.
The tables below summarize the returns of stocks added and removed since 2010. The stocks that were removed performed better than those added, especially in the shorter-term timeframes. Stocks added to the index in December averaged a return of 3.44% over the next three months, compared to an 8% gain for those removed.
Also, in the next three months 46.5% of the stocks added beat the index, compared to 57% of stocks removed. One year later, the stocks added to the index averaged a gain of about 13%, with roughly 34% of them beating the overall index. Those figures pale in comparison to names removed from the NDX, which averaged a gain of 19% in the next year, with 49% of the stocks beating the index.
I can think of a couple reasons why stocks removed would beat those added. For one, the announcement of stocks being added will create buying pressure for those stocks by funds that replicate the index. This buying frenzy will push the stock's price above fair value, causing underperformance going forward. Vice versa for those removed. Plus, new stocks tend to be those that have performed well and have some hype behind them. It’s an indication of bullish sentiment, which has bearish implications based on our contrarian philosophy.
This next table breaks down the three-month returns by year. The stocks removed beat the new additions in only five of 12 years, including the last two years. When they have outperformed, however, it has been by a wide margin, so the overall average return has been better for those removed.
This last table shows how stocks added compared to those removed over the next 12 months. It’s broken down yearly over the past 12 years. The stocks removed beat those added in eight of the 12 years, including the last two years.
Last year, this made for an astounding indicator. The stocks removed averaged a gain of 12%, with all six stocks beating the NDX. Only two of the six stocks added to the index beat the overall index, and those stocks averaged a loss of 45%.
