Fundamental analysis Macroeconomic indicators

Stock Market Anomalies: The FOMC 'Drift' Effect

Elena Berseneva 07 june 2022 55 4

In earlier research, we have looked at several anomalies in the US stock market, such as:


Today, we will study the FOMC “Drift” effect.

 

In July 2011, commissioned by the Federal Reserve Bank of New York, David Lucca and Emanuel Moench published a study on the effect of "drift" FOMC (The Puzzling Pre-FOMC Announcement "Drift").

 

The authors describe the studied effect as follows:

‘’since 1994, more than 80 percent of the premium on U.S. stocks has been received in the twenty-four hours leading up to scheduled Federal Open Market Committee (FOMC) announcements (which occur only eight times a year) - a phenomenon we call "drift" before the FOMC announcement.”

Hypothesis
To conclusion

US stock market indices (S&P 500, DJIA) and US stocks rise in the 24 hours leading up to FOMC meetings.

К выводам
Data used

Financial instruments:

  • indices: S&P 500, DJIA
  • 25 US stocks


Timeframe: D1


Period: April 2004 – March 2022


Signals to enter the market: 2809

Considered US Stocks:


Apple/_AAPL
JPMorgan Chase/_JPM
American Express/_AXP
Coca-Cola/_KO
Boeing/_BA
McDonald’s/_MCD
Caterpillar/_CAT
3M/_MMM
Cisco/_CSCO
Merck&Co/_MRK
Chevron Corp/_CVX
Microsoft/_MSFT
Walt Disney/_DIS
Procter&Gamble/_PG
Home Depot/_HD
Travelers/_TRV
Honeywell International Inc./_HON
UnitedHealth/_UNH
IBM/_IBM
Visa/_V
Intel/_INTC
Verizon/_VZ
Johnson&Johnson/_JNJ
Walmart/_WMT
Nike/NKE



Strategy


Open a long position on indices and stocks:

  • on the opening of an hour, 8 hours before the FOMC meetings;
  • on the opening of an hour, 12 hours before the FOMC meetings;
  • on the opening of an hour, 24 hours before the FOMC meetings;
  • on the opening of an hour, 36 hours before the FOMC meetings;
  • on the opening of an hour, 48 hours before the FOMC meetings.

 

Close the position at the end of the hour just before the FOMC meetings.


 

We will evaluate the trading strategy according to the following criteria:

  • The average return reflects the relative change in quotations of financial instruments in percentage. A positive value of the average return indicates the profitability of the strategy, a negative one indicates a loss.

 

The average return (R) of a financial instrument is given by the formula:

where:

n - the number of transactions;

 

P (%) – the percentage of change in the quotation of the financial instrument at the time of fixing the position, is calculated as follows:

 

for buy positions

P (%) = (position closing price - position opening price) / position opening price * 100%

 

for sell positions

P (%) = (position opening price - position closing price) / position opening price * 100%


 

  • The total return (TR) is the sum of the returns from all trades. The greater the value of the total return, the greater the profit brought by the signal during its testing period.
  • Max drawdown (MaxDD) is the maximum loss in percentage terms from fixing losing trades for the entire testing period. The smaller the value of the maximum drawdown, the better the trading signal works.

where:

n - the number of trades;

R - rate of return;

TRn - total return of n trades;

DDn – drawdown at the time of closing the nth trade;

MaxDD – max drawdown.




Analysis of the obtained results 


Let's look at the results of transactions according to the strategy:

So, as expected, the US stock market indices and stocks really grow in the 24 hours leading up to the FOMC meetings. The exceptions are stocks of Walmart (_WMT) and Travelers (_TRV) (see the appendix for more details).


The average return for indices is 0.38%, for stocks - 0.27%.

 

In addition, a higher return of the strategy with the entry into the market 36 hours before the FOMC meetings is noticeable. For indices, the return increases to 0.49%, and for stocks - up to 0.43%.

 

At the same time, the value of the total return grows for both indices and stocks, except for JPMorgan Chase (_JPM) and 3M (_MMM).

 

The value of the maximum drawdown for indices slightly increases. The maximum drawdown of stocks increases, but for most of them its value does not exceed 20%. The exceptions are Boeing (_BA), Caterpillar (_CAT), Cisco (_CSCO), JPMorgan Chase (_JPM) and UnitedHealth (_UNH) stocks.

 



Let's see how the average return of the strategy changes when closing positions after FOMC meetings:

Obviously, the growth of indices and stocks is higher just before the FOMC meetings.

Conclusion

As expected, US stock market indices and stocks rise in the 24 hours leading up to the FOMC meetings. The exceptions are stocks of Walmart (_WMT) and Travelers (_TRV).



The effectiveness of using the FOMC ‘’drift’’ effect for trading US indices and stocks have been identified.


Moreover, when opening long positions 36 hours before FOMC meetings, profit increases

Detailed results are shown in the Appendix:

XLSX (0.04 MB)FOMC.xlsx

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