Monday, June 30, 2003
Trading Often Wild At June End For Annual Russell Rebalancing
BY KEN HOOVER
INVESTOR'S BUSINESS DAILY
Watch out for the last hour of trading Monday. Wacky things have a way of happening in the stock market just before the close on the last trading day of June.
That's when all 21 Russell indexes â including the Russell 2000 and Russell 1000 â are rebalanced. Some stocks are kicked out while others join.
Stocks going in or out of the small-cap Russell 2000 are affected the most. They have less volume and are more easily jerked around. How it unfolds is unpredictable.
Every year, it's something new and different, said Steven DeSanctis, head of small-cap research at Prudential Securities. It's fun to watch if you're a spectator. It's not so much fun if you're in the market.
DeSanctis says $20 billion is indexed to the Russell 2000. Index fund managers must reshuffle portfolios to match the index. Active managers adjust their sector weightings to match the index.
Hedge funds try to trade ahead of them. DeSanctis says part of his job is to advise money managers on how to deal with the annual madness.
A Wild 60 Minutes
Take last year. It was a sleepy day until 3 p.m. Eastern time. NYSE volume was running 13% below the level for the same time the prior day. Nasdaq trade was 12% off the pace. Then volume surged, sending stocks careening in both directions, mostly down. Most of the action was in the final minutes.
The NYSE traded 2.6 million shares, then a record. That was 31% over the prior day. It was pretty much the same for the Nasdaq.
A 1.9% gain in the Nasdaq Composite was wiped out.
The year before was even worse. The Nasdaq's network systems crashed, forcing the market to close an hour early. To make amends, the Nasdaq reopened for an extra hour, which turned out to be wild and woolly.
This is how The Big Picture described the action in the next day's IBD: Prices jumped back and forth by 10% in some cases. Bid and ask quotes had little to do with last trades. To make matters worse, the Nasdaq composite wasn't updated for hours.
The next day, the Nasdaq was forced to change the closing prices on many stocks.
The Russell indexes are made up of the 3,000 highest capitalization stocks. The Russell 1000 is the 1,000 biggest companies. The Russell 2000 is the smallest 2000 of the 3,000. There also are growth and value components that fund managers watch closely. Their jobs depend on their ability to match or beat those indexes.
The indexes are rebalanced each year on July 1. But Wall Street starts preparing months in advance. Money managers try to gauge what will be added or deleted.
In early June, Frank Russell Co. in Tacoma, Wash., releases a preliminary list of changes to its indexes. A final list was published June 13.
The process is mechanical and public, so professionals with the data can figure out the changes for themselves.
DeSanctis says it's not a game for individual investors.
You're competing with professional traders who have been doing this for years, he said.
A NYSE spokeswoman said the exchange has made no special preparations because our systems can handle it.
The Nasdaq has made special preparations.
We take an all-hands-on-deck approach, said Nasdaq Vice President Adena Friedman. Everybody is on the job and talking to one another so problems are fixed quickly.
The market will also keep the window open so exchange officials can cancel or correct the price of final trades until 5:45 p.m. instead of the usual 5:15. The Nasdaq took the same steps on June 20 when volume swelled in the quarterly quadruple witching.
Russell indexes compute their Nasdaq stocks using official Nasdaq closing prices, not consolidated last sale prices.
The consolidated last sale price includes trades on regional exchanges and preclose trades reported to the Nasdaq as late as 4:01:30. Nasdaq official closing prices include only Nasdaq trades reported no later than two seconds after the close.
If the last trade is outside the closing bid-ask spread, it's adjusted. That means outliers, trades well outside the normal range, can't become the closing price.
That's a big deal to fund managers and their shareholders. The Russell rebalancing coincides with the end of the quarter. It's important to have reasonable closing prices to accurately measure fund performance.
This time rebalancing might not be as wrenching as previous years. DeSanctis says problems are worse if it happens on a Friday or near the Fourth of July when volume is light and prices are more easily pushed around.
This year, say Russell officials, there are fewer changes than usual because 2002's market slide affected most sectors equally.
Just 288 companies are being added to the Russell 3000. The 10-year average is 495. Only 28 are IPOs â down from 317 in 2000.
The biggest category of change was the addition of 72 small banks and S&Ls that did well last year.
DeSanctis says several real estate investment trusts, or REITs, and technology and biotech stocks are graduating out of the Russell 2000 because they are too big.
That hurts those stocks short term because they'll be sold by small-cap indexers, but are still small fry in the big-cap Russell 1000.
Among the good performers being added to the small-cap index are Station Casino, (STN) Del Monte Foods, (DLM) Cree, (CREE) Novell, (NOVL) Nextel Partners, (NXTP) Rambus (RMBS) and Service Corp. International. (SRV)
