Stock Index Traders Need to be Aware of Window Dressing

Stock Index Traders Need to be Aware of Window Dressing

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If you’ve ever watched financial news near the end of a quarter, you’ve heard the term “window dressing”. Many of the talking heads trying to explain a day or a week of market moves in a 3 minute sound bite (disclosure statement: I’m one of them) use the term to fill time and explain the often unexplainable. “It’s the end of the quarter, so we are going to see a lot of window dressing today…” . Today is the last day of Q2, so we ask; what is window dressing? Window dressing is a strategy used by mutual fund and other portfolio managers near the year or quarter end to improve the appearance of a fund’s performance before presenting it to clients or shareholders*.

 

Does it work? Not really. In terms of performance, it has more of a negative effect but in terms of the emotions of the clients, it works like a charm. Even though their fund is under-performing, they love to see that their mutual fund owns Tesla (TSLA), which is +25% for Q2 2017. they think it must be something else causing the poor performance and with stocks like TSLA in the fund, we are sure to bounce back!!!. so where does window dressing come into play for the index trader?

On the last trading day of any quarter, index traders need to be cognizant of stocks that may be subject to this type of blind buying if they are a big part of the index you are trading. Stocks that are large components of an index can keep said index up due to gains attributed to window dressing, even when overall markets are headed lower. As an example of what a couple of stocks can do, on May 25th, Caterpillar (CAT) and Boeing (BA) were both up. CAT was up 1.4% and BA was up .8%. Because of their weighting in the Dow they both individually added 10 points to the Dow’s gain for the day, for a total of +20 points from just 2 stocks.Equities all finished positive that day but if you had been short the Dow and the markets turned, but CAT and BA did not turn, you’d be wondering what happened to your good short trade. If it was the end of the quarter, you could attribute it to window dressing, since both CAT and BA are some of the better performing stocks for Q2 (CAT is up 11.6% and BA is up 13.8% as of this writing).

Window dressing also works in the reverse as bad stocks are sold so clients don’t see them in the portfolio and question the manager’s abilities. So a bad stock may get worse on the last day of any quarter. The strategy doesn’t work and many trades are reversed out when the new quarter begins, but for those of you that like to understand why things happen, look for the effects of window dressing on the last day of any quarter. Or, focus on price action and don’t worry about why things happen. This way you can ignore the knuckleheads on TV, like me.

*from investopedia.com

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