End of Quarter Effect (Strategy) in the Stock Market: Backtest and Performance Analysis
Is there a distinct trend in the U.S. stock market’s returns during the closing days of calendar quarters? Do investment funds strategically allocate cash to drive up stock prices to enhance portfolio values in quarterly reports? Is there a unique end-of-quarter effect strategy that can be differentiated from the turn-of-the-month strategy? In short, is there an end-of-quarter effect in the stock market?
No, our backtests reveal that the end of quarter effect in stocks is mainly a myth. However, performance varies from quarter to quarter.
The media and talking heads frequently mention the end of quarter effect, but our backtests reveal that the effect is a myth. As a matter of fact, if we exclude the fourth-quarter effect, the returns are negative!
If you want other seasonal trading strategies like this one, we have covered many on our landing page of short-term trading strategies.
What is a quarter?
First, let’s start with the basics: A year is divided into four parts:
- First quarter (Q1): starts in January and ends 31st of March.
- Second quarter (Q2): starts in April and ends 30th of June.
- Third quarter (Q3): starts in July and ends 30th of September.
- Fourth quarter (Q4 ): starts in October and ends 31st of December.
Listed stocks are required to report quarterly earnings for each period, and each reporting season might lead to wild swings in stock prices:
How do quarterly earnings affect stocks?
If a company beats or falls short of the earnings expectations, the stock price might rise or decrease by double-digit percentage numbers. Thus, management with a short-term focus might want to “window-dress” its earnings as far as the law and accounting standards allow.
Warren Buffett, a proponent of long-term investing, disagrees and argues reporting once a year is enough. Why? Because frequent reporting leads to behavior mistakes from investors.
Why is the end of the quarter important?
Likewise, the returns at the end of the quarter might determine the quarterly performance of a fund or manager.
Hence, focusing on short-term performance might be very important for the fund and the manager to exist or still have the job. In our opinion, a very vicious cycle.
Hedge funds, for example, frequently get shut down after just a few months of underperformance. Investors usually order redemptions within a few months of weak performance.
What happens at the end of the quarter in the stock market?
Funds and money managers might report results to the owners or stakeholders daily, weekly, monthly, quart