DAVID PARKINSON
From Thursday's Globe and Mail
For the Canadian stock market, it turns out, the adage is wrong: Success does come overnight.
A new study from CIBC World Markets shows that over the past decade, all of the gains on the Toronto Stock Exchange have been achieved while the market was sleeping – in the daily differences between the level at which the benchmark S&P/TSX composite index closes one day and the level at which it opens the next.
Since early 2001, these overnight gains have generated an average annual price gains of 11.3 per cent, compared with 4.1 per cent for the index overall – and an average annual loss of 3.9 per cent during trading hours.
“In fact, an investor who had only exposure to intraday moves would have experienced a 35-per-cent decline in capital over the past 10 years,” wrote CIBC World Markets quantitative strategists Peter Gibson and Jeff Evans.
“In addition, intraday returns have been approximately 32 per cent more volatile than overnight returns, making the results even more substantial on a risk-adjusted basis,” they wrote.
While the researchers haven’t yet identified the root causes of this phenomenon, they largely dismissed one possible explanation – that the market is affected more by key developments that typically happen while it’s closed, such as economic data and earnings reports.
“What’s curious about this is that it’s systematically to the upside,” Mr. Evans said in an interview Wednesday. He noted that the overnight market gains held even in the 2008 downturn, when the economic news was “uniformly negative.”
He also noted that while the overnight effect exists in other equity markets, such as in the United States, “it’s much less pronounced” than in the Canadian market. One possible explanation is Canada’s heavy exposure to natural-resource commodities (resource stocks account for nearly half of the S&P/TSX composite), which may make the TSX more sensitive to overnight commodity price gains in foreign markets.
“We haven’t dug into that yet, but we’re going to take a closer look at it” in follow-up research, Mr. Evans said.
Compensation for Risk
Their best guess, for now, has to do with the uncertainties that dog all investors when the market closes and they must sit, helpless, while overnight developments around the world could derail their best-laid investing plans.
“It’s compensation for the risk of holding overnight,” Mr. Evans suggested.
Regardless of the causes, the finding does imply a very profitable strategy for investors: Simply buy all your stocks each day just before the market closes, then sell them all each morning at the opening bell.
But there’s a rub: All that daily buying and selling would impose onerous transaction costs.
“To implement an overnight arbitrage, an investor would need to transact approximately 500 times per year (buying each evening at the close, and selling at the open the next day, for approximately 250 trading days per year),” Mr. Gibson and Mr. Evan said. Based on typical fees of about 1-cent per share per trade for active retail trading accounts, the costs “are sufficiently high that arbitrage is unprofitable,” they said.
“The strategy would only be feasible for investors with low transaction costs, or if used as an overlay to other strategies with a lower transaction frequency,” they concluded.
“In principle, however, longer-term investors could exploit this discrepancy by shifting trades towards the end of the day. This would avoid unnecessary exposure to intraday price risk for which investors are not being compensated, and increases exposure to overnight ‘gap risk,’ for which investors are compensated.”
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