It’s summer, and trading is light, but here’s something that might perk your interest: Friday is usually the heaviest volume day of the year. It’s the annual Russell Reconstitution, the day when the Russell indexes are rebalanced. There’s $8.5 trillion in asset benchmarked to or invested in products based on the Russell U.S. indexes. Why is this important? Indexes rule the world because passive investing rules the world, and these indexes determine what go into many mutual funds and many ETFs. The main interest is to look at stocks that are going into or out of the large-cap Russell 1000, and into or out of the small-cap Russell 2000. Both are market-cap weighted indexes. Passive investors tied to these indexes will have to buy or sell these stocks depending on how the stocks have performed in the last year. The largest 1,000 by market cap go into the Russell 1000. The remaining roughly 2,000 go into the Russell 2000. The breakpoint — the dividing line between the Russell 1000 and the Russell 2000 — is about $3.4 billion. Nick Note: here is the cruelest Wall Street trick of them all. ALL indices kick out the losers. That way silly people looking at the index to invest always see them going up. The problem is investors can’t kick out the losers until after they lose money. That is why its impossible for investors to get the return the indices show. The cruel trick is they kick out the losers and replace them with a new group of winners. Its a rigged game
How the mighty have fallen. This is where it gets a little fun — traders get to see who gets kicked out of the Russell 1000, and who has risen into the Russell 1000 from the Russell 2000.
Let’s start with the losers, because, well, there’s a morbid sport in looking at once-mighty companies that have seen better days.
No surprise, there’s some big retail names that are being given the boot: JC Penney, which is down to a mere $1.4 billion market cap, and Dillard’s, which is down to $1.5 billion, are both getting kicked out of the Russell 1000. Some former internet/tech darlings are also getting the boot: Groupon, Yelp and Fitbit.
Finally, it’s been a mess for oil companies, and plenty of names are getting tossed: Diamond Offshore, Noble, Ensco, Rown, Penn Virginia.
Steve DeSanctis, SMID-Cap Strategist for Jefferies, notes that the Russell 2000 has traditionally hosted companies on the way up, and then on the way down: “That’s one of the problems with the Russell 2000: You do get a heavy dose of companies that are well past their prime, companies that have to reinvent themselves after being a great company.”
Then there’s the other way around: small companies that are knocking the cover off the ball, and graduating to the Russell 1000.
The best example is AMD, which has had quite a year, going from roughly $5 to $14 in the last 12 months, and adding more shares to boot. “AMD was an also-ran years ago, but reinvented themselves and now they compete with companies like NVIDIA,” DeSanctis told me.
So will there be any price action? DeSanctis notes that stocks going from the Russell 1000 to the Russell 2000 often outperform short-term. Why? Because those stocks are going from being a small fish (a small market cap) in a big pond (the Russell 1000) to a bigger fish in a smaller pond (the Russell 2000). They will gain a larger market weight in the Russell 2000, which will force indexers to buy them, often resulting in a bump up in price.