Plus, a list of stocks that could benefit from window dressing
Window dressing is a deceitful practice where mutual funds and other large institutions buy high-flying stocks and sell off the losing ones just before the end of a quarter, when many funds must report their holdings.
When investors see the funds' holdings at the end of the quarter, they may be impressed by the high-flying stocks and conclude that the fund managers have foresight. They don't realize, however, that these stocks were purchased very recently. Similarly, the fund may have sold off its losing stocks to hide the fact that it invested in them.
I will be looking for quantified evidence of window dressing in recent quarters. Perhaps we can predict stocks that will be affected by this practice over the next couple of weeks.
Window Dressing Quarter
To see if window dressing is evident, I looked at S&P 500 Index (SPX) stocks over the last five years. Then I looked at the preceding six-month return for each stock at a date two weeks before the end of the quarter. I separated the stocks into the 50 best and 50 worst over the prior six months, then tracked the groups' performances over the last two weeks of the quarter. If window dressing is affecting the numbers, we would expect the best performers to outperform the worst performers.
This first table shows the average return for stocks during the last two weeks of the quarter based on how they performed in the preceding six months. Over the past five years, the last two weeks of the third quarter have been bad for stocks. This is clear in the table because of the large negative returns for each group in the third quarter.
The third quarter, however, is the only quarter showing evidence of window dressing. Perhaps buying and selling in other quarters are driven by other factors. For example, the fourth quarter activity could be driven by end-of-year tax considerations. The second table below shows the percentage of stocks in each group that beat the SPX in the past two weeks of the quarter. For the third quarter, the stocks that performed the best in the prior six months had the best chance of beating the SPX over the final two weeks of the quarter.
Stocks to Watch Before the Quarter Ends
Based on the analysis above, below are a couple of lists of stocks to watch for the remainder of the quarter. The first table shows SPX stocks that have done the best over the past six months. The window dressing theory says these stocks should do well in the final stretch of the quarter. The second table of stocks are the worst performers over the past six months. These stocks could face selling pressure in the next week as portfolio managers unload them before the end of the quarter.
