Will Twitter Head Higher as Part of S&P 500?

In today's Daily Market Commentary webinar I received a lot of questions about the announcement that the S&P 500 stock index will be removing Monsanto Co. (MON) and adding Twitter Inc. (TWTR) to the index on June 7. The announcement was released after the market closed on Monday, June 4 and TWTR's stock was up an additional 3.5% in post-market trading. It seems reasonable that when a stock is added to an index, demand will rise and so will the price. The historical track-record, however, is much less convincing.

Not Much of a Factor in the Short-Term

Because many investors are either explicitly or implicitly shadowing the S&P 500 for their own professional or personal portfolio, then demand for TWTR's shares should rise because those investors must now acquire the stock. However, this isn't reliably true. I pulled a few random examples from the list of the most recently added S&P 500 additions and the results weren't very predictive.

Stock Date Added Initial Result
ABMD​​​​​​​ May 31, 2018 +7% over 3 days
TTWO​​​​​​​ March 19, 2018 -9% over 10 days
HLT June 19, 2017 -9% over 12 days
AMD March 20, 2017 -30% over 34 days
CDNS​​​​​​​ September 18, 2017 +18% over 48 days

The list could go on, and on, but it is clear that historically speaking, being added to the S&P 500 seems to neither increase the chances of outperforming the market or underperforming in the short-term. The numbers change to be slightly more positive if we measure the average change in price between the time it is announced that a stock will be added to the S&P 500 and the day it is actually added, but profiting during that period is getting much more difficult. 

For example, TWTR will be included in the S&P 500 on June 7, which is when passively managed indexes should be adding the stock to their portfolios. Theoretically, investors could buy the stock on June 5 and then sell it on the 7 when they expect demand to spike from these stock funds. Like most investment trends, eventually enough investors catch on to the idea and the advantage starts to evaporate. 

Investment fund managers have been changing the way they acquire stocks when a change is made to the index. For example, building a position over time rather than all at once is an obvious way to avoid the risk of buying just at the moment speculators are preparing for the price to spike. Fund managers are slow to change, so we may still see some volatility between the announcement and the actual day a stock is added to an index, but it is fading and more difficult to detect each year. 

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