Discover How Stocks Dumped from Indexes Can Outperform the S&P 500
If you’ve ever wondered why some stocks that get booted off major indexes seem to perform better over time, you’re not alone. Research Affiliates Chairman Rob Arnott and Forrest Henslee have uncovered a compelling reason in their latest report, “Nixed: The Upside of Getting Dumped.” Their findings suggest that stocks ejected from indexes can actually outperform those added, challenging conventional investment wisdom.
Let’s break down what this means and how you can leverage this insight to potentially beat the S&P 500.
Why Getting Dumped Can Be a Golden Opportunity
Stock Ejections and Their Unexpected Upside
When a stock gets removed from a major index like the S&P 500, Russell 1000, or Nasdaq 100, it often faces massive selling pressure. This happens because numerous funds and ETFs that track these indexes are forced to sell their shares, pushing the stock’s price down significantly.
Here’s why this situation can be advantageous:
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Price Pressure and Rebound: The heavy selling can create an oversold condition. Once the stock is out of the index, it has room to rebound, often outperforming the market.
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Historical Outperformance: According to Arnott and Henslee, stocks dumped from indexes have outperformed the broad market index by over 5% annually for the next five years. This is a striking contrast to the stocks added to indexes, which tend to lag by 1%-2% after the initial surge.
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Example from the Past: An investor who focused on dumped stocks from 1991 to 2023 would have seen their wealth increase by a staggering factor of 74. This performance is notably higher compared to investors in S&P 500, Russell 1000, and Russell 2000 Value indexes, who lagged by 55%-65%.
The S&P 500 and Index Additions: A Closer Look
Why New Additions Might Not Be as Attractive
When a stock is added to an index, it often experiences a surge in price. This surge happens because of increased buying from funds that need to include the stock in their portfolios. However, this momentum is short-lived:
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Initial Surge and Fade: Stocks added to indexes generally see a boost between the announcement of the change and its effective date. But this momentum quickly fades. Over the subsequent year, these stocks underperform relative to the broader market.
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Recent Data: From 1990 to 2022, additions to the S&P 500 lagged behind the market by 1%-2%, while stocks that were removed outperformed by over 5%.
Introducing the Research Affiliates Deletions Index (NIXT)
A New Index to Test the Theory
To put this theory into practice, Research Affiliates has launched the Research Affiliates Deletions Index (NIXT). Here’s what sets it apart:
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Investment Strategy: The NIXT index focuses on stocks removed from major indexes like the S&P 500 and Nasdaq 100. It buys these stocks, holds them for five years, and rebalances them annually to an equal weight.
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Proven Performance: Based on historical data, stocks that have been removed from indexes have shown impressive recovery and growth. The NIXT aims to harness this trend and test its resilience in today’s market.
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Past Predictions: Arnott previously predicted that Tesla would underperform the S&P 500 in the year following its addition to the index. His prediction held true, with Tesla lagging behind while the stock that was removed, Apartment Investment and Management, soared 44%.
Why This Matters for Investors
Potential Strategies for Beating the Market
If you’re looking to outperform traditional indexes, considering stocks that have been dumped from major indexes could be a viable strategy. Here’s how you can approach it:
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Monitor Index Changes: Keep an eye on announcements of index changes and watch for stocks getting removed. These could present opportunities for future gains.
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Evaluate Market Conditions: Understand that while dumped stocks have historically outperformed, current market conditions—like a growth-dominated bull market—can impact this trend. Always assess the broader market context.
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Diversify and Research: Don’t put all your eggs in one basket. Diversify your investments and conduct thorough research to identify the most promising dumped stocks.
Final Thoughts: The Upside of Getting Dumped
Arnott and Henslee’s report challenges traditional investment strategies and offers a fresh perspective on index changes. The Research Affiliates Deletions Index (NIXT) provides a new way to capitalise on the potential of stocks that are removed from major indexes.
Understanding and leveraging the trends in dumped stocks could be a key strategy for those looking to outperform the S&P 500. With careful research and strategic investment, you might just find the next big winner in the market.
Links for More Information:
- Research Affiliates: Research Affiliates Deletions Index (NIXT)
- Rob Arnott: Rob Arnott Insights
- Forrest Henslee: Forrest Henslee Profile
- S&P 500 Performance: S&P 500 Historical Data
- Tesla vs. S&P 500: Tesla and S&P 500 Comparison
