Market moved higher in anticipation of good earnings

Market started a move higher in mid August. One of the factor possibly driving this move higher was the earning. If you have been following the earnings picture , you would have got a good understanding that the earnings were very healthy in spite of the doom and gloom scenario. Sometime market moves in anticipation and sometime it moves post earning. Lot of earning expectations is already priced in to these levels so there might be a correction till the future earning trend becomes clear. But let us watch and see. For several quarters now companies have been underpromising, analyst have been under estimating( effect of post Blodget phenomenon)and companies are handily beating estimates.

On individual stock levels same thing happens. Once you understand this game in detail and if you make an effort to look below the hood and go in to microscopic detail in to how these things work, you will find many wonderful ways to profit from it on both long and short side.

Immense amount of energy and efforts are spent by the shrewed investors, the big investors, and the Goldman Sachs of the world in trying to get a handle on earnings. Especially for large cap stocks and S&P the game is about anticipating earnings ahead of the crowd.Talk to any large mutual fund managers or pension fund manager or some very successful hedge fund managers and the language they talk is all about earnings and valuation. Trillions of dollar asset allocation depends on the P and E factors.

If you see some of the widely followed and profitable methods on street like Value Line or CANSLIM , they are all based on earning momentum.

The formula is secret, but Value Line does publish some of the ingredients that go into it. Stocks tend to get high ranks if they have a run of quarterly earnings gains, beat analyst forecasts and have recent share-price gains in excess of the market's. There's a bias, in other words, toward momentum plays. This is a run-with-the-crowd system, and it makes sense for in-and-out traders.

Paradoxically, the Value Line ranking system is also useful for the polar opposites of momentum players, namely, contrarian investors. They go for out-of-favor stocks, often with recent earnings disappointments, on the theory that these will eventually make a recovery and reward patient holders. Here it makes sense to start with the stocks ranked lowest for near-term performance.

Look at some of the very shrewed traders interviewed in Market Wizard. Focus on some who have had a track record of very high returns and under that you will find earnings based strategies. Mark Minervini who was on of the most reticent trader in those interviews, essentially follows an earning plus price momentum based strategy, if you read below the surface. Publicly available data shows he had several triple digit years.

Mark Boucher the author of The Hedge Fund Edge: Maximum Profit/Minimum Risk Global Trend Trading Strategies is another hedge fund manager who had in early days triple digit returns. He describes in detail his methodology for short term trading in that book.It all boils down to earning and price momentum.

I always like to focus on traders who made triple digit kind of returns when I read or interact with traders. My logic is simple, if I can understand even half of what is their methodology and can adopt it, I am better off than following someone who makes 20% per annum.So when I meet some of them, I badger them with questions till they are tired. Another book which has interviews of traders with triple digit kind of returns is The Best: TradingMarkets.com Conversations With Top Traders . Now if you look at the methodology of some of the traders interviewed in that book who had years with very high returns you will find earning and momentum as two common threads.

I have been studying currently the history of mutual funds and some of the most successful funds which had very high returns for an extended period of time ( they may not be super performers currently) and the common thread in their success, you guessed it right, is earning and momentum.

Few weeks ago, I was approached by a trader and software developer who was enamored by the book How I Made 2,000,000 in the Stock Market by Nicolas Darvas and wanted me to test his software. I told him Darvas success had nothing to do with the box theory, it was more to do with his stocks selection. If you see the stock he selected to trade they had either very high earning growths or momentum during that period. If you select right stock, anything even technical analysis works on it. He was not convinced and continues to perfect his boxes.

Obviously it is not simple to covert the understanding that earnings move markets and stocks in to profitable method. You have to go in to lot more details to make it work. Similarly momentum based strategies work provided they are designed properly.

Once you understand the earning and momentum game, you don't need the CNBC, or any other analyst. You might be able to figure out for yourself why I said months before anyone else that oil stocks are headed for correction. When you start to understand and read earnings, you will notice many things like these before most analyst. It is my submission that most traders get lost in he technical analysis jungle early in their trading career because there are so many charlatans selling them the magic potions, that they never find a way out of that jungle.

The other problem is most of what you hear on TV and read about on many immensely popular blogs is macro analysis. Now macro style trading is not for everyone, certainly not for those trading few millions. Even the best of the investment banks do not depend on macro traders to make their year. What macro traders make is bonus to them.

For an individual trader equity selection is the key to superior returns. Earning and momentum based strategies is one of the proven ways select equities. There are other also.

Don't take my word for it. (only 50 people read this blog!!!) Question everything.Be your own analyst. Be your own guru.


walter said...

easy guru, you wrote: Market started a move higher in mid August. One of the factor possibly driving this move higher was the earning. If you have been following the earnings picture , you would have got a good understanding that the earnings were very healthy in spite of the doom and gloom scenario.

well, what about all the downward revisions? what you say doesnt really jive with that...

walter said...

roubini's idea of a suckers rally seems to make more sense than everyone anticipating good earnings... but i have to admit, when it comes to earnings analysis and anticipation, i am useless


Pradeep Bonde said...

Which downward revisions are you talking about. My data indicates most of it started in last couple of weeks not in August.
Many analyst may be playing safe now after imbibing lot of negativity. Plus as a general observation on earnings, bad news is promptly relayed with pre announcement while good news on earnings is hoarded by companies to susprise market, to work on secondaries, to raise cash and to screw shorts.

walter said...

AA had pre earnings downward revisions and then on earnings day they missed even harder...

walter said...

this is interesting:

Two Points From The Bear Case

Found via SeekingAlpha, we pull two points out of fund manager John Hussman's bear case on the market.

[1] Historically, if we look at points where the Fed has cut rates at least twice, it has invariably been either during or just prior to a period of substantial earnings weakness. We don't typically observe strong earnings growth coupled with fresh Fed loosening cycles, except on the back-side of recessions. ....

[2] On the valuation front, the current P/E ratio for the S&P 500 is 18 times record earnings (on record profit margins). Historically, the combination of an inverted yield curve and a P/E ratio over 15 has been associated with negative market returns, on average. The only time we've observed an inverted yield curve and a P/E at or above 18 times record earnings was at the 2000 market top. The runner-up (just below 18) was near the heights of the “Go-Go” market leading into the '69-'70 bear market.