After its famous ARK vs. Berkshire Hathaway chart, the Financial Times recently published another strong chart. It shows that the overnight return, the return between the closing and opening of the stock exchange, is many times higher than the return realised during regular stock exchange hours.
This FT graph is based on research by Bruce Knuteson (2022). He has a somewhat daring theory that the high overnight return is caused by one or more large quant investors driving up the prices of shares they own during the less liquid evening hours.
When the market opens, they sell these shares again, thereby reducing the return during regular hours. But because liquidity is much greater then, and shares go up on average, selling creates less downward pressure, leaving a positive result.
The explanation sounds almost like conspiracy theory. There are however some simpler ways to explains this. The first is a simple calculation. On normal days, the US stock exchange is open for 6.5 hours. That is barely a quarter of a 24-hour period. If returns were realised completely evenly over the day, it is not surprising that the returns are higher during all those hours that the stock exchange is closed.
Profit figures
But more importantly, returns are not evenly distributed at all. Asset manager Alpha Architect calculated that 25 percent of all earnings figures are announced within 30 minutes of the market closing and another 60 percent before the trading day begins.
Since earnings figures are the most valuable information investors get - you can wonder why the stock market has to be open 6.5 hours a day anyway - combined with the fact that companies make it a sport to exceed often understated expectations, it is no surprise that most of the returns are made outside of regular hours. It is sometimes less complicated than it seems.
The key question
So far nice to know. The key question is whether you can build an investment strategy around them. The answer, according to Alpha Architect, is “no”. If you include the costs of implementing such a strategy, the “statistical robustness of any outperformance is low,” according to Alpha Architect. A big advantage, however, is that this is a strategy that lets you sleep well at night.
Jeroen Blokland is founder of True Insights and knowledge expert of Investment Officer.