- Speaker #0
Hello, welcome back to Papers with Backtest podcast. Today, we dive into another algo trading research paper. Okay, let's unpack this. We're talking about the payday anomaly. You've probably heard of the turn of the month effect, right? Yeah. You know, where stocks tend to do a bit better at the beginning and end of the month.
- Speaker #1
Right. There's a pretty well-established pattern there.
- Speaker #0
Exactly. Well, this paper explores a similar pattern, but this time it's happening mid-month and it's all tied to, you guessed it, Paychecks.
- Speaker #1
It's fascinating, isn't it? The researchers looked specifically at the 16th of the month and found that it consistently outperforms other days when it comes to S&P 500 returns.
- Speaker #0
Wait, hold on. Are you saying it beats out even the first and second of the month? Those are classic payday days too.
- Speaker #1
Well, the first and second still hold the top spots, but the 16th is right up there with them. The research suggests it's all connected to when those semi-monthly paychecks land and those automatic retirement contributions hit the market.
- Speaker #0
Okay, so let me get this straight. You're telling me that my 401k contributions, along with everyone else's, might actually be nudging the market upward around the
- Speaker #1
16th. That's the idea. And think about it, even if you're not directly trading the S&P 500, understanding these patterns can be really insightful. It shows you how something as seemingly unrelated as paychecks can create ripple effects throughout the market.
- Speaker #0
I love that. It's like a hidden connection, a behind the scenes look at what moves the market. Now, I got to ask, how did the researchers uncover this pattern? Did they just look at recent data or did they go deeper?
- Speaker #1
They went deep. They used S&P 500 data going all the way back to 1950. We're talking about a massive data set spanning decades.
- Speaker #0
Wow, 1950. That's impressive. So what did they find when they looked at this huge chunk of market history?
- Speaker #1
Here's where it gets really interesting. It turns out the 16th hasn't always been a top performer. Its outperformance actually became more pronounced after the
- Speaker #0
1980s. Interesting. The 1980s. What was happening back then that could explain this shift? Well,
- Speaker #1
remember, the 1980s saw a major shift towards defined contribution retirement plans like 401ks. That meant more people were making automatic investments tied directly to their paydays. More money flowing in, potentially pushing prices up mid-month.
- Speaker #0
Ah, that makes sense. More 401k money, more buying pressure on the 16th. But wait, you mentioned earlier there's a twist to this story. What's that all about?
- Speaker #1
Right. This is where things take another turn. It seems the anomaly might be weakening in the
- Speaker #0
2010s. Weakening? Why would that be happening? Are people suddenly stopping their 401k contributions?
- Speaker #1
Not exactly. The researchers suggest it might be due to the rise of biweekly pay schedules. Instead of everyone getting paid on the 15th and the end of the month, the inflow of funds is more spread out.
- Speaker #0
That's a great point. So even something as simple as a change in pay schedules can potentially disrupt a market pattern that's been around for decades.
- Speaker #1
Exactly. And this highlights why it's crucial to keep up with research and understand how seemingly small changes can have big impacts over time.
- Speaker #0
OK, so we've talked about the history and the potential reasons behind this payday anomaly. But the million dollar question is, how can we as individual investors or traders actually use this information?
- Speaker #1
Well, the paper doesn't hand us a ready-made trading strategy, but... it definitely gives us some intriguing possibilities to consider. For example, if you're making regular investments, like adding to your portfolio every month, you might want to experiment with timing those investments around these payday days.
- Speaker #0
I see what you're saying. Instead of just buying on the first of the month, you might get a slightly better return by waiting until the
- Speaker #1
16th. That's one way to look at it. Of course, this is just one study, and more research is always needed, but it's definitely something to consider.
- Speaker #0
Right. It's about opening up new ways of thinking about the market, right?
- Speaker #1
Exactly. And this brings us to the heart of how the researchers approached their analysis. You see, they actually used a surprisingly simple tool to analyze this mountain of data.
- Speaker #0
Oh, come on. Don't tell me they used some supercomputer or a complicated algorithm to crack this code.
- Speaker #1
Not at all. They relied heavily on something you probably have on your computer right now, pivot tables in a spreadsheet program.
- Speaker #0
Pivot tables. Seriously, that's amazing. It shows you don't always need fancy software. to uncover valuable insights. Sometimes the simplest tools can do the trick.
- Speaker #1
Absolutely. It's a great reminder that anyone can get involved in research and explore these fascinating market patterns.
- Speaker #0
Now, you mentioned that the study primarily focused on the S&P 500. Did they hint at whether this payday anomaly might exist in other markets or asset classes?
- Speaker #1
That's a fantastic question. And it's one the researchers themselves raise. They suggest that there's a whole world of potential research to be done. in exploring this anomaly in other markets.
- Speaker #0
I'm already thinking about international markets. Imagine if pain schedules are different in other countries. Wouldn't that lead to even more pronounced anomalies?
- Speaker #1
Exactly. And think about different asset classes. Could we see something similar in bonds or commodities? The possibilities are endless.
- Speaker #0
This is getting me excited. It's like a treasure map pointing to all sorts of hidden market patterns waiting to be discovered. Okay, so we've established this payday anomaly might exist. But let's get to the practical stuff. Did the researchers outline a specific trading strategy based on their findings?
- Speaker #1
They did. And it's surprisingly simple. Their strategy boils down to buying and holding the S&P 500 index on the 16th day of each month. And that's it. No complex algorithms or indicators, just pure timing based on this payday effect.
- Speaker #0
Wow, that's about as straightforward as it gets. But did this simple strategy actually work? Did it hold up in backtests?
- Speaker #1
That's the key question, right? And here's where it gets really interesting. Their backtests, covering the period from 1980 to 2010, showed an average annual return of 2.57% just for holding on the
- Speaker #0
16th. Hold on. 2.57% just for buying and holding on a specific day? That's pretty impressive, especially considering how simple the approach is.
- Speaker #1
Exactly. And to give you a sense of the risk-adjusted return, the Sharpe ratio for this strategy was a respectable 0.6. It means you're getting a decent return without taking on crazy amounts of risk.
- Speaker #0
Okay, this all sounds promising, but let's be realistic. No strategy is perfect. What about the potential downsides? What does the research say about that?
- Speaker #1
You're right. We always need to consider both sides of the coin. Unfortunately, the paper doesn't provide specific data on the maximum drawdown, which is a measure of the biggest potential loss you might face.
- Speaker #0
That's a shame. It's always important to understand the potential downsides, not just the potential upside. But even with that missing piece, this payday anomaly and the simple strategy built around it is really intriguing. It makes you think differently about how the market works.
- Speaker #1
Absolutely. And there's one more important caveat the researchers highlighted. This strategy, while potentially profitable, isn't a good hedge for bear market.
- Speaker #0
That makes sense. It's a strategy designed to capture a specific market pattern, not to protect you when the entire market is going down.
- Speaker #1
Precisely. It's all about exploiting an inefficiency, but it doesn't change the fact that you're still exposed to overall market risk.
- Speaker #0
Got it. So it's not a magic bullet, but it's a potential tool in the toolbox. Now, you mentioned earlier that the researchers made some assumptions in their analysis. What were those? And how might they affect our understanding of this anomaly?
- Speaker #1
Right. It's always important to be aware of the assumptions researchers make. In this case, they made two key assumptions. First, they assumed that those semi-monthly paychecks are distributed on the 15th of each month, meaning those retirement contributions would land in financial institutions by the end of the day, ready to be invested the next day, the
- Speaker #0
16th. Okay, so there's a bit of a lag between when people get paid and when their retirement contributions actually hit the market.
- Speaker #1
Exactly. And their second assumption was that a significant portion of those retirement contributions are invested in broad market funds, like those tracking the S&P 500. That's why their study specifically focused on the S&P 500.
- Speaker #0
So if those assumptions aren't entirely accurate in the real world, the whole pattern could be different.
- Speaker #1
That's right. It's crucial to keep these assumptions in mind and consider how they might affect the anomaly's strength or even its existence in different contexts.
- Speaker #0
That's a really important point. Now, before we move on, I'm curious. Did the researchers mention anything about how major economic events might impact this payday anomaly?
- Speaker #1
They did touch on that. They raised the question of whether a significant economic shift like a sudden spike in unemployment could disrupt this pattern. After all, fewer people employed means fewer paychecks hitting the market.
- Speaker #0
Right. It adds another layer of complexity and highlights how these market patterns aren't set in stone. They can be influenced by real world events.
- Speaker #1
Absolutely. It's a reminder that we always need to consider the bigger picture and how broader economic forces might interact with these anomalies.
- Speaker #0
OK, I think we've covered a lot of ground here. Let's take a quick break and then come back to discuss some of the additional details and implications of this research.
- Speaker #1
You know, one thing that really struck me about this research was the deep dive they took into different pay schedules used by companies. You have weekly, biweekly, semi-monthly. It gets pretty complex.
- Speaker #0
Yeah, I remember you mentioning that earlier. It seems like something so basic. but I never really thought about how it could impact the market.
- Speaker #1
And here's the kicker. There aren't any federal laws dictating how often companies have to pay their employees. It's mostly regulated at the state level, meaning a company in one state could be paying weekly, while another in a different state might be doing semi-monthly.
- Speaker #0
So this whole payday landscape is a patchwork of different practices, potentially creating variations in those payday-related market effects.
- Speaker #1
Precisely. And to make things even more interesting, Some states have different payday requirements, depending on the type of job. It's a fascinating area to explore further, especially when considering how these variations might impact the strength of the payday anomaly. in different regions or sectors.
- Speaker #0
OK, so we've got this complex web of pay schedules, and it's potentially influencing the market in ways we're only beginning to understand. Now, I know the researchers call for more investigation into this payday anomaly. What are some of the big unanswered questions you think future studies should tackle?
- Speaker #1
One of the biggest questions is whether there's a true cause and effect relationship between those semi-monthly paychecks and the higher returns we see on the 16th.
- Speaker #0
Just because two things happen around the same time doesn't mean one causes the other. It could be that something else entirely is driving those returns. And the paychecks are just a coincidence.
- Speaker #1
Exactly. And another avenue ripe for exploration is looking beyond the S&P 500. Could this payday anomaly exist in other markets?
- Speaker #0
Right, like those international markets we were talking about earlier, with their own unique pay schedules. Imagine if there are even stronger anomalies in markets where more companies use semi-monthly pay schedules. Or what about different asset classes altogether? Could we see something similar happening in bonds or commodities?
- Speaker #1
Now you're getting it. There's so much more to uncover here. It's a reminder that we're always learning, always discovering new things about how the market works.
- Speaker #0
Okay, so we've unpacked the anomaly itself, explored its potential causes, and even looked at some simple trading strategies based on this research. What would you say are the three key takeaways our listeners should remember about the payday anomaly?
- Speaker #1
First, remember there's evidence of unusually high returns in the S&P 500 on the 16th of the month, likely connected to those semi-monthly paychecks and retirement contributions.
- Speaker #0
So potentially an interesting opportunity for timing those S&P 500 investments.
- Speaker #1
Precisely. Second, keep in mind that this anomaly appears to be strongest since the 1980s, which, as we discussed, coincides with the rise of those 401k plans and more automatic investing tied to paydays.
- Speaker #0
Got it. The timing of the anomaly makes sense in light of those broader financial trends. What's the third takeaway?
- Speaker #1
This one's important. Remember that this anomaly seems to be weakening in recent years, possibly due to that shift towards biweekly pay schedules.
- Speaker #0
All right. So the pattern might be evolving and it's essential to stay informed and keep an eye on these trends.
- Speaker #1
Couldn't have said it better myself.
- Speaker #0
This has been an incredible deep dive. It's amazing how something as everyday as paychecks can potentially influence the stock market, even if it's just a subtle effect. And I love how the researchers used a simple tool like pivot tables to uncover these patterns. It's a great reminder that you don't need fancy software to do meaningful research.
- Speaker #1
Absolutely. There's a real elegance in finding those simple, effective solutions. And as we discussed, there's so much more to explore in this area. I'm excited to see what future research uncovers about this payday anomaly.
- Speaker #0
Me too. Just goes to show that the market is full of surprises. And there's always something new to learn. But before we wrap up, I have one final, thought-provoking question for our listeners to ponder. Ooh,
- Speaker #1
I love those. What have you got for us today?
- Speaker #0
Okay, so the paper we discussed focused on the relationship between paychecks and stock market returns. But what about other financial decisions people tend to make around paydays? Could those have an impact on other areas of the market?
- Speaker #1
Oh, I see where you're going with this. It's like a ripple effect, right? For example, do people tend to pay down debt more aggressively right after getting paid? Could that create predictable fluctuations in things like bond yields or interest rates?
- Speaker #0
Exactly. Or what about consumer spending? Do retailers see a surge in sales on or around payday? Could that information be valuable for understanding trends in specific sectors? Or even predicting future earnings reports?
- Speaker #1
Those are fantastic questions. It really challenges us to think beyond the traditional boundaries of market analysis and consider the broader economic ecosystem. How do individual financial behaviors, often tied to those regular paychecks, influence the intricate dance of the market?
- Speaker #0
It's like we're seeing the market through a new lens, recognizing these interconnected patterns that might otherwise go unnoticed. And who knows what other fascinating insights are waiting to be discovered.
- Speaker #1
It's a reminder to stay curious, keep questioning, and never stop exploring. There's always more to learn, more connections to uncover, and more ways to potentially gain an edge. and understanding the market's intricate workings.
- Speaker #0
Well said. And on that note, I think it's time to wrap up this deep dive into the payday anomaly.
- Speaker #1
I agree. It's been a fascinating journey.
- Speaker #0
Thank you for tuning in to Papers with Backtest podcast. We hope today's episode gave you useful insights. Join us next time as we break down more research. And for more papers and backtests, find us at https.paperswithbacktest.com. Happy trading.
