The Unstoppable Overnight Effect: Why the Stock Market is Better at Night

In a world where instant gratification often rules our financial decisions, the stock market has presented a recurring phenomenon that requires patience and discipline. Recent analysis from Dow Jones, as discussed by Mark Hulbert, reveals an intriguing finding: the best time to own stocks is actually at night. This so-called “overnight effect” has garnered a reputation among researchers as the “grandmother of all market anomalies.” It’s time to take a closer look at why the U.S. stock market performs significantly better during overnight hours than during the day.

Impressive Statistics that Can’t Be Ignored

Consider this: over the 12-month period leading up to April 15, the S&P 500 (SPX) gained an impressive 6.6%. However, a portfolio that stuck solely to overnight investments would have outperformed that figure, registering a 6.8% gain. Strikingly, more than 100% of the stock market’s gains during this period occurred when the exchanges were closed. On the contrary, a portfolio that held the S&P 500 exclusively during regular trading hours would have seen a negative return. These statistics scream of a serious market anomaly, one that warrants attention from both seasoned investors and newcomers entering the fray.

Long-Term Trends Backing the Overnight Theory

The recent statistics are not merely a short-term blip. A 30-year study conducted by an advisory firm, Elm Street, analyzed market behavior from 1992 to 2022 and concluded that investors reaped 100% or more of the market’s buy-and-hold return while the markets were closed. In stark contrast, trading during open hours yielded zero to negative returns. This long-term evidence underlines the solidity of the overnight effect and its potential worthiness in your investment strategy.

The Practical Aspects: Challenges and Opportunities

Now, you might be thinking that exploiting the overnight effect is as simple as setting your watch for the market’s close each day. In reality, it requires a series of trades that can add up quickly—more than 200 trades a year, to be exact. You would need to buy a broad-market fund, like the SPDR S&P 500 ETF Trust (SPY), at the close (4 p.m. Eastern time) and sell at the next day’s open (9:30 a.m. Eastern time). However, many discount brokers now offer commission-free trading, which mitigates the cost associated with such frequent transactions.

It’s essential to highlight that while this pattern shows promise, it also comes with transaction costs that could subtract about 1% from the overnight portfolio’s returns. Thus, employing an overnight trading strategy may be better suited for tax-deferred accounts, as the frequent trades will be taxed at the higher short-term capital gains rate.

Understanding the “Why” Behind the Overnight Effect

For you to invest based on the overnight effect, it’s crucial to understand why it exists. A study titled “Overnight Post-Earnings Announcement Drift and SEC Form 8-K Disclosures” conducted by researchers at the University of California, Berkeley, and the University of Western Australia, pinpointed one of the key reasons. They attributed the overnight effect to the U.S. market’s reaction to extreme earnings surprises, which predominantly occur when exchanges are closed. For example, a recent earnings surprise from Travelers Cos. (TRV) reported an EPS of $1.91—almost three times higher than expected—which resulted in a significant stock price jump as trading commenced.

This evidence points to a larger strategy: slowly and steadily accumulating gains from many such surprises over an extended timeline. Although not every earnings report will bring positive news, they’ve historically trended toward the upside, boosting stock prices more significantly when markets open.

The Bottom Line: A Strategy Worth the Wait

Some might be tempted to see the overnight effect as a get-rich-quick scheme; however, it’s anything but. While it may not promise overnight riches, its long-term historical performance and the persistence of this phenomenon make it a potential investment strategy worth considering. But patience and discipline are necessary for any investor prepared to enter the market at every close and exit at each open.

As we witness the U.S. economy navigating through various challenges, understanding these market dynamics and employing time-tested strategies could very well be the cornerstone of a strong investment portfolio for those who adhere to conservative financial principles.