The following is an excerpt from STEVEN M. SEARS | July 14, 2012 | Barrons.com |
It is now much in vogue to observe that stock-market correlation is high.
With all stocks seemingly rising and falling as one, with little regard for their individual merits, the fashionable trade is to ignore stocks.
The better approach, says the new conventional wisdom, is using exchange-traded funds and associated call options to profit from the rapid risk-on, risk-off trading patterns that now define the stock market. To take a stand on the fundamental merits of a stock is seemingly ill-advised.
But a recent Goldman Sachs study suggests investors should stop worrying so much about correlation, at least during earnings season.
After analyzing stock-trading patterns around 42,000 earnings reports over the past 16 years, Goldman Sachs’ derivatives strategists found that the week around earnings season is unusually important to the total annual returns for stocks. Picking the right stock is obviously the critical part of the equation, but investors who buy the right calls on the right stocks around earnings reports insert themselves into an incredibly important time in a stock’s annual trading pattern.
“We estimate that the seven days around each company’s earnings report accounted for over one-third of the annual return of stocks since 1996 despite only accounting for about one-tenth of the days,” the strategists, John Marshall and Katherine Fogertey, wrote in a report, “The Case for Owning Stocks on Earnings Day,” which was published in late May.
The earnings-week phenomenon was even more sharply pronounced in information technology, industrial, and consumer-discretionary stocks. Earnings periods accounted for more than 50% of annual returns in those sectors over the past 16 years.
The strategists attribute the outsize performance around earnings to nervous investors selling stocks ahead of earnings reports and then racing to repurchase shares when the results are better than expected.
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