S&P/TSX Composite Index Changes Offer New Growth Opportunities

Includes: DIA, QQQ, SPY
by: Market Blog

By David Parkinson

Now that Standard and Poor's has announced its quarterly changes to the S&P/TSX composite index, Derek Euale can tell you how much money you could have made if you'd only listened to him a couple of weeks ago.

Mr. Euale, an analyst at CIBC World Markets who tracks the index and predicts S&P's changes in advance of the stock-index company's quarterly announcements, pointed out that of the 10 changes S&P announced to Canada's benchmark stock index last Friday (nine additions and one deletion), he had correctly predicted nine of them in a report issued Nov. 30. That was the final day of market data that S&P uses in its quarterly review of index membership. (Read more about it: Benchmark to grow again and S&P/TSX composite set to bulk up)

S&P lays out its criteria for stocks' inclusion and exclusion from the index very clearly in its published methodology (it's based largely on market capitalization and liquidity), so anyone with a decent calculator and the willingness to take the time to crunch the numbers can make a pretty accurate prediction as to the changes S&P will make each quarter. Even before the final days of trading used for the index calculations, it's quite possible to predict, with reasonable certanty, the stocks most likely to be affected in the quarterly review.

But if all that sounds like too much work, you can let index analysts such as Mr. Euale or UBS's Garry Cooper do the work for you - both publish their index-change predictions in advance of S&P's quarterly announcement. And, as Mr. Euale points out, it pays for investors to act on these predictions.

If an investor had adopted a strategy of going long all the stocks being added to the index, and short the stock being deleted (with each stock weighted equally), he or she would have enjoyed a return of a whopping 9.3% over the 15 trading days prior to S&P's announcement. Even five days before the announcement, the strategy would yield a 1.5% gain.

If you missed the boat on the predictions, there's still opportunity here. The index changes don't actually take effect until after the market closes this Friday (Dec. 18); history shows that stocks being added to the index typically advance in the week between the index announcement and the effective date, while stocks being deleted typically decline.

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