While stock market patterns over time tend to demonstrate that the market goes up or rallies on the first day of the month, it does not mean that it happens every single month, and it's certainly not something you should consider as an investment strategy. Investors and analyst have a few theories as to why the market sometimes tends to trend upward on the first day of the month.
Fresh Money with 401(k) Deposits
There is a theory that the stock market gets a fresh injection of investor cash on the first of the month due to 401(k) deposits. This is under the assumption that that employers transfer employee 401(k) deposits to the 401(k) trustee on the last day of the month. The trustee then transfers the funds to the designated financial institution or bank that manages your company's 401(k) within the usual time of 24 hours. The investment manager receives the 401(k) deposits on the first day of the month and invests the deposits accordingly. The theory is that these investments then lead an injection of investor cash in the market, causing the market to go up.
So-called window dressing occurs when mutual fund managers sell a portfolio's underperforming securities to buy better performing securities right before the portfolio's performance report is due. The window dressing theory only applies to portfolios or investments that have monthly performance reports. Window dressing makes the portfolio look like it is performing better than it may have been over the month. Under this theory, portfolios dump underperforming securities on the last day of the month, causing a decline. They then buy the dumped securities back on the first day of the month, causing the market to go up.
Purpose of Window Dressing
Window dressing may seem unethical and unprincipled, but it is not illegal. Window dressing gives investors the appearance that the manager isn't being too risky with their money. When a portfolio manager dumps a stock at the end of the month and buys it back at the beginning of the month, he is making a risk-on trade. This, theoretically, could also contribute to a boost in the market at the beginning of a month.
The beginning of every month marks a fresh start for investors and money managers. Because of this fact, their sentiment is positive. Think of it this way, every month a money manger starts at zero. That means, zero gains and zero losses for the month. Positive investor sentiment at the beginning of the month can cause the stock market to go up.
- USA Today; First Day of the Month Usually a Winner for Stocks; Adam Shell; September 2010
- The Wall Street Journal; Much of the Month's Move is on the First Day; Jonathan Chang; March 2011
- Technical Analysis; National University of Singapore Department of Finance and Accounting; Investor Sentiment, Market Timing and Futures Returns; Chanyung Wang; September 2000
- Financial Dictionary; Window Dressing
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