Listening To A Poet To Navigate Earnings Season
Maintaining Focus While All About You Are Losing Theirs
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Right before companies began reporting earnings in the middle of October, Bloomberg data indicated that options on stocks in the S&P 500 looked to be pricing in a 5% average move on their earnings releases – close to the highest level of implied volatility (“IV”) since 2022. IV is a measure of the expected future price movement of stock… either up or down.
Investors were probably right to expect bigger moves on these reports, because data from global investment bank UBS shows that volatility on earnings has been consistently rising for years. Five years ago, the average stock price change following an earnings release for an S&P 500 stock was about 3.7%. This was mid-2020, the height of the uncertain times of the COVID-19 pandemic. By 2022 that average earnings move had risen to about 4.5%. And last quarter it was 5.5%.
Keep in mind, those moves are for large-cap stocks in the S&P 500. These are many of the biggest and safest companies in the index. For smaller-cap companies that make up a much greater percentage of the total stocks being traded out there, the volatility is considerably higher.
There are a few reasons for the increased volatility. The rise of overall leverage – borrowing to invest – in the financial system is no doubt driving a significant amount of the volatility. And there is also more uncertainty about the economy – with risks around tariffs, inflation fears, and ballooning government deficits. But most importantly, the proliferation of hedge funds targeting their trading around earnings news is a huge contributor. This is indicative of greater “short-termism” in stock trading – investors are looking solely at the latest report and missing the bigger picture.
Focusing so much on the very short term can lead investors to make big mistakes over the long run – missing out on great stocks that have one bad quarter. For people who are in the market every day – both the institutional investor and the day trader – this kind of volatility can affect both emotions and judgment. And this is not just about investing. It could play out in any important choice one makes. Making a highly emotionally charged choice is rarely the better route to a calm and rational one.
Investors would be wise to read “If,” by late 19th-century English poet Rudyard Kipling – it’s about having resilience when facing adversity. He writes…
If you can keep your head when all about you are losing theirs…If you can meet triumph and disaster and treat those two impostors just the same… Yours is the earth and everything that’s in it.”
This might be some of the best advice investors can heed during turbulent times. In this latest update of the Big Secret On Wall Street, we review five stocks where investors are focusing too much on the short term. Two of the stocks are insurance companies that were effectively penalized for making too much money. There is a tobacco giant that continues to see robust growth but its latest earnings news raised some misconceptions on pricing regarding its key new smokeless product. Then there is a leading candy maker whose results are being suppressed by temporary factors that will inevitably reverse. And finally, we look at one of our “legal monopolies” that continues to face near-term obstacles from the Department Of Government Efficiency (“DOGE”) but yet appears to be pricing in all that risk and more.
Emotions and volatility may be running high, but let’s keep Rudyard Kipling in mind and focus on the facts and the bigger picture.
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