Mention the word “rebalance,” and most investors think of the boring annual process of buying and selling in order to reset the weight of each asset class in their portfolios.
It’s a chore, yes. But it’s a simple, proven way to maximize returns, while minimizing risk.
But today, I want to cover a lesser-known rebalancing event – but one that promises to be the busiest trading day of this year – and perhaps ever.
I’m talking about the annual rebalancing of the small-cap Russell 2000 Index.
Here’s what you need to know – and why this year’s rebalance could be historic…
The Russell Rebalance Is Underway
Once every year, FTSE Russell recalibrates the widely followed Russell indices to keep them in sync with the broader market.
According to Convergex, there’s approximately $850 billion in funds tied directly to tracking the Russell 1000 and 2000 indices. That means every time the indices change, a substantial portion of this money needs to be re-allocated.
Doing so ensures that funds’ portfolios match up with any stocks that are being added or removed from the indices they’re designed to track.
This year, Convergex estimates there will be nearly $50 billion in turnover caused by the reconstitution of the Russell indices, involving 398 stocks.
Understandably, this flood of buying and selling materially impacts share prices. In short…
- If you own stocks being added to the Russell 2000, you can expect to enjoy a one-month double-digit boost to share prices of about 11%, on average.
- If you own any being deleted, a decline of 2% (on average) is headed your way.
And remember, those are the only averages. Individual stocks can move much higher (or lower).
The reason I’m bringing all this up today is because the process is about to be completed.
D-Day Is Tomorrow
Unlike many cushy private clubs, each company has to qualify every year to be included in the Russell indices.
On May 27, Russell officially ranked every U.S. public company based primarily on market cap. (Trading liquidity and available float are also taken into consideration.)
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Last year, the cutoff was around a market cap of $175 million. This year’s cutoff was lower – $133 billion – given the decline in stock prices over the last 12 months.
On June 10 and 17, preliminary lists of companies being added and deleted were released.
But the final list will be released tomorrow (June 24), with the changes set in stone after the market closes that day.
This will be a very big day for small-cap stocks.
Possibly bigger than any other rebalancing day on record.
“Brexit” Amps Up the Volatility
During a typical Russell rebalance, trading volumes reach a crescendo at the end of the day – typically the last five minutes, as funds rush to match their portfolios with end-of-day prices for stocks that are joining or leaving the index.
Now, in case you’ve lived under a rock for the past few months, you’ll know that this year’s flood of buying and selling will also occur on the day after the United Kingdom votes on whether to leave the European Union – the so-called Brexit.
While the British public is voting today, the results won’t be reported until after the closing bell.
Since the results hold profound implications for the global markets, Friday morning promises to be a potentially volatile trading day in its own right.
Factor in the Russell rebalance, and we could be in store for one of the busiest small-cap trading days ever.
This is an instance when short-term price action will have absolutely nothing to do with companies’ underlying fundamentals.
So if you own or are looking to buy any small-cap stocks in the next two days, you absolutely need to be aware of the companies set to be added or deleted from the Russell 2000 – and even those on the bubble – because the changes will directly impact share prices.
You can find the preliminary list of additions and deletions here.
Ahead of the tape,