Magazine

Don't Bet the Bank on Early-Hours Trading


When stock markets in Europe take a big plunge because of late-breaking news, Todd E. Petzel hops out of bed and rushes to his computer to buy or sell futures contracts. As chief investment officer at $26 billion Commonfund Asset Management Co. in Wilton, Conn., he can't afford to wait until the U.S. markets open. Says Petzel: "At certain times in the night, the only way to reduce a position is sell in the futures markets."

By jumping in early, are managers like Petzel helping to shape market trading that day? Not really. The small group of big investors around the world who trade in stock index futures prior to the U.S. markets opening aren't even setting the stage for whether the equity markets will rise or fall in the first 15 minutes of trading. Contrary to the conventional wisdom, repeated daily on CNBC, Bloomberg Radio, and local TV and radio stations--that the futures predict the day's market performances--an examination of the data by BusinessWeek shows hardly any correlation.

That may come as a big surprise to market players who've been taking it as an article of faith that the futures offer a solid guide to the day's trading. Trading records since the beginning of this year show that even in the first 15 minutes after the New York Stock Exchange and Nasdaq open at 9:30 a.m. (Eastern time), the markets move in the same direction as futures only a little more than half the time (table). This slim correlation is quite remarkable, considering that the pre-market futures on the S&P and the Nasdaq 100 trade until 9:15 a.m., and the Dow premarket futures trade right up to the opening of the stock markets. As the day's news moves the markets still further, the correlation barely changes, except for the S&P, where it gets a lot worse.

To some longtime traders, the lack of predictive power in the futures is not so surprising. They say the number of investors playing the markets in the big index contracts is small. Overnight traders make up just 2% to 4% of the overall market, according to data from the Chicago Mercantile Exchange. "The lack of liquidity distorts the price movements by magnifying them," argues George Gero, senior vice-president for investments at Prudential Securities Inc. Adds Michael A. Manning, chief executive of Rand Financial Services Inc., another Chicago futures broker: "Typically, it doesn't take much to create a wide swing in the overnight markets because they're so thinly traded--which is why they are a poor indication of where the markets are heading on the upcoming day."

DIGESTION. Nonetheless, some investors swear by them. "Even if the markets are extremely thin, the futures help digest overnight information," says Jack Bouroudjian, president of Commerz Futures Corp., a Chicago broker. To make their case, such believers can point to days when the futures have been almost eerily on target.

One such banner day: Mar. 14. While most Americans slept, the credit-rating firm Fitch IBCA placed 19 Japanese banks under review for a possible downgrade. This, combined with profit warnings from Europe, put markets across the Atlantic into a tizzy. People expected the U.S. stock markets to open sharply lower.

So banks with proprietary stock holdings and money managers turned to the stock index futures. That led to frenzied trading, and by early morning the Nasdaq 100 had traded down 65 basis points, the limit set by the Chicago Mercantile Exchange before it halts trading. Futures on the S&P 500 index had also slid to their 32-point limit, and the Dow futures lost as much as 330 points. And what happened to stocks? The Dow closed down 317 points, the Nasdaq lost 43, and the S&P dropped 31 points. "Usually the tail wags the dog early, and then stock markets take over--but on occasion, as we saw, the tail wags the dog all day," says Commerz Futures' Bouroudjian.

But such days are more the exception than the norm. One needs to look no further than Mar. 21. At 9:15 a.m., futures on each of the stock indexes were up slightly. At the end of the day, each closed down sharply, with the Dow caving 233 points. Most of the time, the odds of getting reliable guidance from the futures markets are as good as turning up heads while flipping a coin. By Pallavi Gogoi in Chicago, with Susan Zegel in New York


We Almost Lost the Nasdaq
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