The curious case of rising stocks in the night-time

The witching hour was said to be the time of night when demons, ghosts, ghouls and witches were at their most powerful. It's also when the US stock market is at its best.

According to a study by the New York Federal Reserve, most of the gains on the American stock exchanges occur after the market closes in New York. Early morning returns tend to be negative. Many analysts have been puzzled by the phenomenon.

It gets weirder. Bruce Knuteson was a quantitative analyst at the hedge fund DE Shaw. Knuteson has a more controversial interpretation of the pattern than other researchers have. He thinks that it is caused by market manipulation by quantitative hedge funds.

Line chart of Cumulative returns (%) showing Stocks work best at night

Knuteson thinks that funds that use algorithmic or systemic strategies take advantage of the bigger impact that trades can have when markets are closed. They drive their price higher by aggressively buying shares they already own.

As markets open and trading conditions improve, they can gradually ditch the purchases. Knuteson says they should have a slightly higher-valued portfolio by the end of the day. He argues that day-in-day-out would produce a pattern of overnight gains and gentle declines.

The DE Shaw background of Knuteson makes his theory more intriguing than the usual conspiracy theories. DE Shaw didn't say anything. How plausible is it? Not very.

The US stock market is only open for a short period of time. You can practice trading around the clock. George Pearkes has calculated that if one adjusts for the different lengths of trading windows, the average returns are not that different.

The New York Federal Reserve study showed that returns spike between 2am and 3am in New York. This is when European traders get to work, and not what Knuteson's theory would suggest.

A quarter of US corporate earnings releases are published after the market closes, and another 60 percent before the market opens. The phenomenon of companies beating estimates and then having price spikes in the overnight trading session is explained by this.

US stocks enjoy upward drift when European traders get to work

There are many other technical factors that play a role, such as derivatives or index funds buying in the closing auction. The costs of trading and insuring against any disastrous tumbles would almost certainly take up any gains from such a strategy anyway, according to the quants.

The idea that big hedge funds could manipulate markets on a stunning scale over several decades and across multiple countries without a single regulator, trading firm or money manager noticing defies belief.

These explanations don't satisfy Knuteson. He thinks regulators are either incompetent or blind to the fact that people like stock markets going up.

Over the years he tried to convince some journalists to write about his paper and when they mostly declined he started publishing his correspondence with them in a paper he titled "They Chose to Not Tell You." He published a sequel called "They Still Haven't Told You", again excoriating hapless regulators and journalists.

Why did you write about this? It's to let others make their own decisions. To show how markets can produce all sorts of delightfully weird anomalies caused by under-appreciated, often boring technical factors, most of which are in practice impossible to exploit but can lead to all sorts of fanciful theories.