Wild stock market action on earnings shouldn't happen!

Tech company Nvidia NVDA surged over 15% February 22nd 2024 following the release of earnings. NVDA received a lot of attention for its stock market achievements but it wasn't alone. Wild price swings on earnings was a daily event through earnings season, some with big gains others with huge losses. On Feb. 29th OKTA, BYND, AI, CELH, PSTG and MEG all bolted higher by as much as 20%. Others weren't so fortunate as their stock prices saw massive losses on heavy selling by mutual and pension fund managers.

It's great news for accounts holding big winners but what about the extreme earnings casualties?

Random unpredictable action is an issue with navigating the stock market. While NVDA surged on earnings another tech industry leading stock Pan Alto Networks PANW plunged 28%. For those that recognize technical signals in the stock market it was just a few days earlier tech stocks, as a group, triggered sell signals. So how would you have known to hold NVDA but sell PANW?

After the internet bubble of the late 90's burst security regulators charged several organizations and individuals with criminal charges under existing security laws. Martha Stewart was one of them, eventually spending four months in jail. In the early 2000's a number of new laws were set in motion effectively blocking leaks on earnings between public earnings release dates. That seemed like good news at the time, but was it?

The underlying premise of public markets security legislation is transparency and disclosure. But ask yourself this question how do the laws serve the public when mutual fund and pension fund managers move stocks by extreme amounts immediately following earnings results and less so the rest of the time? How does the average person know where to position capital with the obvious unpredictable uncertainty that shows up every three months? 

This shouldn't happen!

The truth is it would be easier to recognize trends and make more timely buy and sell investment decisions if the stock price moved more gradually day after day based on what is being learned by all investors. Early birds would be rewarded!

The intent of security legislation in the public markets is to provide transparency and disclosure but the process isn't efficient. Private company investors can potentially know more about the company they invest in by doing their homework and getting the relevant information whenever they want it, but not in the stock market.

The earnings season is an investment environment that is far too speculative for intelligent successful investing. The crypto markets don't suffer the same fate.

Time the stock market: ignore the herd!

When a stock market up trend finally comes to an end it tends to fool just about everybody. But there are certain signs that may tip you off and reward you for being on top of it.

Contrarian indicators are indicators that point to the timing of a trend change when the general viewpoint is in opposition. Some of these work at market peaks and others work well when the stock market bottoms out.

The stock market is a strange thing for investor psychology and it's not just the general mindset of the market. It's also about how we as investment portfolio engineers handle it. See the following so you may build useful knowledge of how the stock market works.

Related: How to beat the markets.

Put-call ratio

The options market is notorious for demonstrating investor exuberance and, at the other extreme, fear. The put-call ratio for equities tends to spike sharply higher right near the low of large dramatic stock market declines. It shows how investors have loaded on put options in an attempt to hedge portfolios or attempt to profit from the market's decline. When fear takes over the number of puts purchased overwhelms call buys.

Historically the put-call ratio needs to be above 1.0 before selling in the market comes to an end. In the last several years this ratio has been 1.2 at its extremes. During the Covid 19 bear market the put-call jumped to 1.30.

Long term put-call performance

Stocks trading above moving average(s)

If you track the number of stocks above moving averages stat. you'll see how extremes on the upside coincide with market peaks. It works reasonably well at market lows too although only at the most extreme bear market declines.

While the swings may appear short term, many market consolidations are normal over the course of a longer term up trend. Day traders might be able to use this measure but for the average investor and fund manager watch this isn't over used.

Stocks above the 200 day moving average

Preferred Shares

You wouldn't think preferred shares would tell us anything but this area of the stock market was profoundly useful during the credit crisis. In fact preferred shares were the first detectable part of the market turn down and it was long before the stock market went into its historic nose dive.

CPD on the TSX (Canadian market) is an E.T.F. that may be used to detect a break down in conditions that can trigger a stock market decline. While its usefulness will likely diminish over time it can be added into the arsenal of contrarian indicator analysis.

Baltic Freight Index

The Baltic Freight index isn't going to be ranked as one of the better contrarian indicators but it can provide more evidence to identifying a down trend in the stock market.

How to time the market with sentiment indicators

A review of these sentiment indicators can be useful especially when the stock market has been trending higher for a while. They don't necessarily require daily review but when the market is approaching an extreme your awareness can pay off nicely.

Stock splits; no free lunch

Stock splits and reverse stock splits are common occurrences in the stock market. But realistically they don't mean anything. Here's why.

What is a stock split?

Let's look at what a stock split is using an example. In June 2014 Apple AAPL had a 7:1 stock split. If an investment account had 100 shares of AAPL prior to the split the value of the investment would have a market value of approximately $5,863.

From the table below you can see what the account would look like post split. With a a 7:1 split the account would now have 700 shares and the value of those shares would be adjusted accordingly. In this case they would be reduced by 1/7th bringing the share price to $83.76. Prior to the split the stock was trading around $586/share.

Note; the numbers are split adjusted and ignore changes in the share price which of course occurs all the time in the stock market. From the stock chart (below the table) you can see the stock price rose 1.6% on June 9th closing at a price of $85.10/share. The price change is irrelevant to the understanding of a stock split.

Apple's stock has split four times since the company went public. The stock split on a 7-for-1 basis on June 9, 2014, a 2-for-1 basis on February 28, 2005, June 21, 2000, and June 16, 1987. You can find the history of stock splits for all of your stocks of interest at Stock Split History.

What does it mean?

A stock split does not change the value of the underlying investment. All it does is change the share price and the number of shares, by the same ratio, as announced by the company for their split. Here's another way of looking at a stock split.

You go over to Granny's house and as always she has served a great dinner. Now out comes the desserts and this time she's gone all out. There are cakes and pies and you have to decide where to start. Usually you go for the cherry pie but this time there is a pecan pie which is a rare treat at the best of times. So you decide you're going to dig into the pecan pie this time. After asking around the table who wants some of that pecan pie an argument ensues as nobody can agree on what they're going to eventually eat. So instead of cutting the pie into two halves you compromise and suggest you'll cut the pie into quarters. You realize that if there is enough pie left over you can always have another piece. Here's what it would look like if you had just served yourself half the pie or if you wait it out like a good guest and eat two pieces of the pie after it was cut into quarters.

You may have ended up eating two pieces of pie instead of one but but the pieces were smaller (half the size). The total amount of the pie eaten was the same and the pie itself never changed its total size regardless of how many pieces it was carved up into. It's the same for the company who has undergone a stock split. Apple, in our example, did not undergo a change in its total market value. All that happened was the capital structure was sliced up into more shares.

Why do a stock split?

Companies will typically announce a stock split because retail investors have this thing where they think they can't buy higher priced stocks. By keeping their share price lower more retail investors may acquire the stock supporting the theory that more buyers will drive the stock price higher. After all the number one job for management of publicly traded companies is to make shareholders money.

The curse of reverse stock splits

A reverse stock split is when the number of shares is reduced for the purpose of raising the price of the stock (or any other type of security).

The reverse stock split is undertaken when the share price is so low (under $1) that any change in price becomes larger as a percentage change in value (securities trade in increments of one cent). It typically occurs in securities that have suffered a large decline and are effectively in danger of trading down to zero. So management declares a reverse stock split creating a higher share price. For any account that already holds the security the number of shares would go down by the corresponding increase in price. Let's use an example to illustrate.

Oil market security HOU is a two times performance E.T.F trading on the TSX (Toronto Stock Exchange). With a huge decline in the price of oil HOU went under a dollar in late April 2020. On April 28th a 1:20 reverse stock split or rollback went into effect. For every share previously owned an account would now have 1/20th the share quantity. See the table below and note the investment value or market value is the same (excluding normal price changes) on a split adjusted basis.

In the chart of HOU the date of the reverse stock split or rollback is where the red arrow is.

What stock splits teach investors

1. A stock chart is a useful tool for understanding a security and what it means for your investment strategy. In both a stock split and a reverse stock split there is no free lunch. The trend pre-split typically continues after the split as seen in our two examples here. The trend is your primary indicator.

2. Sell signals are your master: Stock market history has been a very valuable guide when it comes to security selection and stocks or E.T.F.s undergoing reverse stock splits are notorious examples. The lesson from HOU and other oil E.T.F.s isn't so much about understanding reverse stock splits it's to know what to keep your hard earned money out of.