Couples who manage their own stock investments should note that stock prices and returns tend to rise on the last day of the month and for the next three days of the following month. Recently, Purdue University researchers Jin Xu and John McConnell found that from 1987 to 2005 all excess market returns occurred during this four-day interval. There is no clear indication of what causes this trading phenomenon; however, certain events that take place during the end of month can cause stock prices to rise. Being aware of these events can guide your stock trading decisions.
The Payday Hypothesis
If you have a job and own stock and other investments, you probably receive a paycheck, along with dividends and interest, by the end of the month. This monthly event explains the payday hypothesis; many investors tend to add to their stock portfolios new 401(k) investments, stock dividends, interest and other funds they receive at the end of the month. The influx of new investment funds can raise equity prices as demand for stocks rise. The research shows that the trading that occurs on the last day of the month provides a boost to the following month’s first two-week returns.
Effect of Institutional Investors
Institutional investors can impact equity prices due to the large trading volume that takes place for the mutual funds and other investment vehicles they manage. When the end of the month coincides with the end of a quarter, money managers have a tendency to dump losing stocks and buy up winning stocks. These transactions are aimed at improving their quarterly results that are reported to and evaluated by the investing community. This end-of-month strategy can raise certain equity prices of the stocks that are in demand.
Effect on Small-Cap Stocks
The end-of-month phenomenon has a more pronounced effect on small-cap and low-priced stocks. The research shows that small-cap stocks have considerably higher returns on the last day of the month versus high-cap stocks. This finding is not considered a variation of the historical trend among small-cap stocks to outperform high-caps. Having said that, high-priced or large-cap stocks can also experience the end-of-month effect.
When the end of the month falls at the end of the year, prices can also rise due to the purchase of new investments and the sell-off of losing stock positions for tax purposes. When tax returns are filed, stock losses incurred by the end of the year can offset the year’s stock gains. The end-of-year stock selloff and subsequent purchases also occur to enhance end-of-quarter and calendar-year fiscal reporting. These end-of-year transactions can drive up stock prices and returns in an effort to improve financial reporting results.
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