A number of weeks ago I made a post which discussed the potentially groundbreaking work Xavier Gabaix and Ralph Koijen called Where Index Investing and Meme Stocks Meet. In that post I discuss the theory that the authors posited about how large inflows into stocks could produce price pressure which may be able to be predicted and captured by market participants. The author’s hypothesis potentially could augment or even upend the efficient market hypothesis that underpins much of global wealth and portfolio management.

When Gabaix and Koijen wrote their paper earlier this year, although they presented a large amount of back tested data which seemed to support their hypothesis, they noted that there were many factors that could affect inflows into equity. These include QE by the Fed, changes in investor sentiment which increase inflows into stocks, share buybacks by large firms and dividends. They acknowledged that much more research needed to be done to supplement their hypothesis and test it. They have examples of different areas that could be tested.

A recent paper by Samuel Hartzmark and David Solomon looks specifically at dividends and how the payment dates may have a small and unanticipated effect on the daily return of indexes both domestically and internationally. Before I get into that however, it is worth noting that the concept of anomalies in market returns is not new and has been observed for some time.

Market Anomalies and the Efficient Market

The efficient market hypothesis, which was first argued by Eugene Fama, a professor at the University of Chicago, basically says that excess returns above the market return cannot be consistently made. Therefore there is no “alpha” or return in excess of the market return to be had. His hypothesis says that all relevant and impactful information is already reflected in the price of every stock. This underpins much of the move towards index funds because if you can’t beat the market, the next best thing you can do is to try to lower your costs as much as you can to try and match the market. This is where the concept of simply investing in index funds started to gain traction.

There have been many who have come out against this hypothesis including Wareen Buffet, who has managed to beat the market consistently for many years (although not recently), but there are other examples that defy the efficient market hypothesis or EMH as I will call it from here on out. One of those is the presence of anomalies which are consistent bumps or falls in share prices that can’t be explained by fundamentals. Some of these include the tendency for returns to be lower on Mondays, the outperformance of small cap stocks over time and that January returns tend to be higher.

If you are an astute observer, you may notice that the media is riddled with these rules of thumb (or superstitions some may say) or “heuristics “ as behavioral economists reefer to them as. Yet as many of them appear and become known, they often disappear as people pile into them to try and earn a higher return and end up contradicting the historical anomaly. This would lend some credence to the EMH. Fama even tried to answer his critics with a paper that showed When value, small cap size and beta were taken into account, all the “higher” long term returns could be explained by greater risk, except for value investing, which today still stands alone as the only strategy anomaly that consistently beats the market over long time periods.

Yet Economists and theorists aren’t in the market every day, traders are and many traders have noted that there are often examples in their day to day which fly in the face of EMH. Some of these can be institutionally related and some can be due to the structurally related as Gabaix and Koijen argue. An example of this that has been known for some time is the tendency for share prices of tech companies to fall in the days after large vesting occurs for their employees and they are allowed to sell. In anticipation of this, traders can take a short position in the shares or buy puts which mature around this time to take advantage of the short term price pressure.

A Focus on Dividends

This brings us back to the recent paper in question by Hartzmark and Solomon. These authors specifically looked at dividends and whether on days where there were large repurchases of stocks due to reinvestment of dividends by asset managers, this put unique upward pressure on prices regardless of the fundamentals at play for the news for that day. The main conclusions and important observations that I gathered from their paper were as follows:

• Research has shown that most dividends are consumed, however an important portion of them are reinvested.
• The authors control for different market moving effects as well such as Fed announcement days, days of the week and end of month effects
• This also seems to hold internationally as well if a country’s market has a high dividend payout on a particular day, returns are also higher that day.
• However, likelihood of reinvestment matters. In the 4th quarter a large number of asset managers make big end of year dividend payouts. Asset managers are less likely to reinvest these since they will use much of the cash to pay their own investors. So during the 4th quarter, the dividend payments do not predict market returns. On the opposite end the researchers find that in the 1st quarter, reinvestment is highly likely so there is a significant dividend effect on prices.
• They also found that over time the effect of this has increased and they attribute this to mutual funds and ETF’s becoming ever more important holders of equity.
• They also found that liquidity, measured by the VIX index also matters: when liquidity is low, the price effect can double.
• There is also some predictive returns to be had from those stocks which have a lot of price pressure due to dividends and those that don’t. The stocks that saw the highest price pressure in the previous 12 months tended to underperform those that had the most price pressure during that time.
• The authors also find that company stock expense, or the compensation paid to employees in stock. These owners only have a small window to sell their shares which usually falls right after an earnings announcement. Firms in the top 5% of stock expense have returns of more than -1.17% in the four days after their earnings announcement.

How to Implement a Strategy Around This

Curious to see if anything big like this was coming up, I decided to look and see if I could quickly find a date when a large amount of stocks would be paying dividends. I landed upon the TipRanks site which shows the ex-dividend date of stocks traded on the NYSE. About 283 stocks went ex-dividend on September 20, yet they do not all have the same payout date. The Nasdaq website has a dividend calendar that shows the payout dates as well and I noticed that many of the stocks going ex-dividend had payout dates on September 30.

Looking back on what happened, the Nasdaq closed at 14,512.44 and opened on the 30th at 14,582.60 and increase of 0.48% yet on the 30th the Nasdaq ended up falling below the previous day to 14,448.58. Not exactly compelling stuff but mine was just aback of the envelope date and guess on inflows based on a Google search.

Another look brought me to the site Market Chameleon which aggregates the ex-dividend and payment dates across different markets and this pointed to October 1 being a date when 281 stocks paid out dividends which was indeed an up day for the market. Another site Market Beat provides aggregated data for free but on a rolling basis. Without breaking it out into excel, I can see that some important dates include that September 30th date for dividend payouts as well as October 15th which is coming up. Luckily this data can be downloaded into an excel sheet so a quick look on what dates have the largest payouts may be able to be discerned from this data and we can test the hypothesis ahead of time if the 15th of October indeed is a large dividend reinvestment date.

The data used by the authors comes from the Center for Research in Security Prices or CRSP or “crisp” as it is known. This database is only available to academics as well as third party providers who would pay for access to the data and use software to present it to their customers. In order to continue examining this on my own, it may make sense to think about a subscription to third party software which has access to this database. I am in the process now of looking into this. If readers have any recommendations on this, it would be greatly appreciated.

If not in October then the next viable date when dividends could impact prices will fall around March of next year. In addition, the research on company stock compensation could make for a good short list of companies to short post earnings call. Either way, this exciting new research seems to be pointing in the direction of at least some short term profits for those who have the capital and time to research the opportunities.

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