Trade the month end balancing act
AS February draws to its inevitable conclusion, what impact does the passing of another month have on the markets? Though Treasuries or corporate bonds show no significant end-of-month effects, there is a noticeable and measurable effect in equity and in forex markets.
THE FIX IS IN
Month-end fixings relate to the moves that portfolio managers need to make to their currency hedges based upon the performance of the equity markets. These portfolio managers usually shift the weightings of their portfolios at the end of each month if the market has seen larger moves than they anticipated
With the S&P up 0.249 per cent since the start of the month, it is expected that US dollars will need to be sold on the fix to cover this rise in equity valuations. If your fund followed the S&P and rose 2.5 per cent in line with the February move and cable has strengthened by 4 per cent, you are going to see your gains wiped out.
Taking a simplified approach, if you were a UK equities portfolio manager in the month of February to date, holding a fictional portfolio of 50 per cent UK equities and 50 per cent US equities, with both tracking the FTSE and the S&P respectively, your UK equities would have risen 2.53 per cent compared with the 2.973 per cent rise in your US stocks. As a result you would need to sell 0.21 per cent more dollars on the February fix to protect your portfolio against dollar risk. Since you are UK-based you have no need to hedge against sterling moves.
Taken individually, these hedging moves aren’t going to have a significant effect. But done on the same day and across the board they have a major effect on price action.
FEBRUARY FIX
Compared to the last 18 months, the February month-end moves aren’t going to be enormous. However, according to David Rodriquez, quantitative strategist for FXCM, the recent trend has favoered closing speculative positions: “The euro has rallied substantially as large speculators closed shorts.” Can this continue into 29 February? “Absolutely,” says Rodriguez. “According to CFTC Commitment of Traders data, large speculators have scaled back their net-bearish euro-dollar positions by 17 per cent in the past month.” Rodriquez adds that there may still be a fair distance to cover, and further short-covering could push the euro to fresh highs against the suddenly-downtrodden Greenback.
END OF MONTH EQUITIES
It’s not just month end fixing that has an effect on equity markets. Research carried out by Wei Xu and John McConnell in a paper entitled “Equity returns at the turn of the month” looked at daily returns for a broad range of stocks across exchanges from 1926 to 2005. They found that all major market returns occur during a four day turn of the month interval – since the beginning of 1987, the daily value-weighted (equal weighted) excess market return during the turn of the month is 0.14 per cent compared with -0.01 per cent over the other 16 trading days. Though it was not limited to small caps, they found that small caps showed especially high returns on the last day of the month (see chart, below.)
These end of month variations are not in themselves the key to a successful trade, but they could be the difference between a winning and losing position.