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Posted 12/27/2001
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The Speculator
Real bargains at Nasdaq’s After-Christmas Sale
What's true on the S&P holds for the Nasdaq 100: The stocks booted out tend to outperform their replacements. And if you pick 'em up, here's how to pick your price.
By Victor Niederhoffer and Laurel Kenner
A small group of traders gathered recently for a friendly end-of-year poker game at the Kennerhoffer School of Bargaining to exchange ideas and review lessons learned. Mostly, the talk was of how to duplicate the 100% return that Mr. P helped garner for his hedge fund this year.
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"I just used the same Christmas Eve bargaining principle that I told you about last week, the one that got me that Jaguar for 25% off," said Mr. P, who prefers anonymity.
"Yes, Mr. P," Vic said. "Watching your costs and picking your spots is key. But that's only a beginning."
"True enough," replied P. "And since you mentioned it, I challenge you to apply the techniques I used in my Christmas Eve special to individual stocks."
"Done," said Vic. And as the students laid down their cards to listen, Vic outlined the Kennerhoffer School's After-Christmas Sale Strategy, which employs the techniques of Mr. P as well as a few other methods that are part of the curriculum here.
MSN Money's Jon Markman wrote an article a couple weeks back showing that stocks expelled from the Standard & Poor's indexes perform better after removal than the stocks that replaced them, contrary to the conventional wisdom. Jon, who doubles as Kennerhoffer editor, noted that the S&P generally kicks out stocks after they've tumbled, and he speculated that expulsion may bring on a selling climax that finally clears the way for buyers of these hated stocks.
We decided to extend his work by looking at what happens to stocks booted from the Nasdaq 100. Nasdaq adds and removes stocks each year at about this time, based on the number of shares outstanding and the stock price, with the aim of reflecting the current economy.
Since 1995, we found the performance of the Nasdaq 100 December deletions and additions has been as follows:
The anti-Nasdaq 100 effect
| 1 mo. avg. chg | 6 mos. avg. chg | |
| Deletions | 10.4% | 22.5% |
| Additions | 6.9% | 14.0% |
| Index | 5.7% | 9.8% |
There are about 10 additions and 10 deletions each December, giving a sample size of 60 for each.
This year's rebalancing became effective Dec. 24. For shoppers looking for markdowns, here are this year's outcasts:
| Stock | Year-end 2000 | 12/20/01 | YTD Return |
| Ariba (ARBA, news, msgs) | 53.63 | 4.90 | -91% |
| BroadVision (BVSN, news, msgs) | 11.81 | 2.62 | -78% |
| CMGI Inc. (CMGI, news, msgs) | 5.59 | 1.51 | -73% |
| CNET Networks (CNET, news, msgs) | 16.00 | 7.25 | -55% |
| 3Com (COMS, news, msgs) | 8.50 | 5.77 | -32% |
| Inktomi (INKT, news, msgs) | 17.88 | 6.15 | -65% |
| Level 3 Communications (LVLT, news, msgs) | 32.81 | 5.07 | -85% |
| McLeodUSA (MCLD, news, msgs) | 14.13 | 0.36 | -97% |
| Metromedia Fiber Network (MFNX, news, msgs) | 10.13 | 0.45 | -96% |
| Novell (NOVL, news, msgs) | 5.22 | 4.54 | -13% |
| Palm (PALM, news, msgs) | 28.31 | 3.46 | -88% |
| Parametric Technology (PMTC, news, msgs) | 13.44 | 7.80 | -42% |
| RealNetworks (RNWK, news, msgs) | 8.69 | 5.41 | -38% |
Cutting it a little finer, we found that the four companies with the worst year-to-date performance before their removal tended to perform better than the rest of the expelled stocks one and six months later. For the statistically minded, the correlation coefficients of the YTD performance with the following one- and six-month periods are -0.18 and -0.12, respectively. The table below shows the negative correlation at work:
The worst-4 bounce best
| All removed | Worst 4 | |
| After 1 Month | 10.4% | 13.2% |
| After 6 Months | 22.5% | 28.7% |
Once again, this shows that the best bargains lead to the best returns. If you're a super-bargain hunter, the four expelled Nasdaq 100 stocks with the worst performance this year are McLeodUSA (-97.5%), Metromedia Fiber Networks (-95.4%), Ariba (-89.8%) and Palm (-88.3%).
For a complete workout of our Nasdaq 100 study, write to dciocca@bloomberg.net.
While our After-Christmas Trade may bring in a nice result after six months, it's based on some basic principles about price that we think could inspire a lifetime of similar ideas.
No price is too low
The important thing to remember is that you don't have to take the first price quoted.
Duncan Coker, a 20-something friend of ours who has had occasion to bargain with real experts -- Third World merchants -- says his greatest challenge is getting his opening bid low enough.
"I often think I will insult the seller going in too low, but this is not the case," Coker reports. "Once when I was looking at rugs in Turkey I went in with an opening offer half the price I was willing to pay. After many mint teas, we settled somewhere in the middle. Later, a Turkish friend told me that the correct opening price was 1/10th of my offer."
Don't worry about offending the seller -- or, in the stocks bazaar, the market maker. After all, even a transaction below average cost may benefit a seller with excess inventory, as N. Gregory Mankiw observes in "Principles of Microeconomics."
Sex and bargains don't mix
One of Vic's traders, Patrick Boyle, in his previous career as a hotelier, says he rarely admitted to a customer that more than one room was available even if half of the hotel was empty. His first price quote was much higher than he thought the customer would accept. "Sometimes the person would pay, and if they wouldn't, they were much happier when the price dropped," Boyle says. "Often I would have customers in the exact same types of rooms, some paying $40, some paying $400."
"The greatest mistake people could make was to come in during busy season and say, ‘Please tell me you have a room,'" he adds. "That automatically tacked an extra $75 on to their room rate. The only bigger mistake was for a young guy to come in with his new girlfriend. He would never want to appear cheap by bargaining, and that was always worth $100."
Boyle also took advantage of the attractive properties of round numbers, well known to stock traders. "Usually people looking for a room have a price in mind, for example $200 per night. If you priced rooms a little above round numbers like that you could increase profitability, because they would happily pay $210 rather than drive around any more."
Those lessons -- the flexibility of price, the undesirability of being eager, and the exercise of care around round numbers -- are all eminently applicable to buying stocks.
"It is important," Boyle concludes, "to always be friendly. No one wants to reduce the price for someone they dislike."
Remember that it's a free society, and it's not shameful for an individual to say what price under the quoted one he would buy at.
Adopt a doleful mien
To the question, "How do you do," Beethoven would often answer, "As well as a poor musician can do."
-- Norman Lebrecht, "The Book of Musical Anecdotes"
Vic's friend and mentor, Steve "Hobo" Keeley, has a technique that applies to all situations. When buying a product, he invariably puts on a doleful expression and after looking the purveyor in the eye, sighs, "Look, we're both God-fearing people. How much do you need over cost on this?" Or, "What's your best dealer (price) on this?"
You're unlikely to find much leeway at the post office on the price of stamps, but the price of most things can be negotiated down. Don't be afraid to ask for a better price on anything you buy, including a stock. This lesson may be particularly relevant at ends of years, when people sell fallen angels for tax purposes.
We thank our readers for all the encomia, observations and augmentations that you've kindly shared with us over the past year, and wish all a happy 2002.
At the time of publication, neither Victor Niederhoffer nor Laurel Kenner owned or controlled shares in any of the stocks mentioned in this article.
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.