Testing Earnings Season (Alcoa to Wal-Mart) Trading Strategies

Four years ago, a reader noted and asked: “CNBC’s Fast Money cited a ‘seasonal’ strategy described in Barron’s, as follows: Go long the market from Wal-Mart’s (WMT) earnings release until Alcoa’s (AA) earnings release and short the market from Alcoa’s earnings release until Wal-Mart’s earnings release (earnings season). Over the last six years, the market has been up nicely during the former period and down an average 8% during the latter. Any testing on this?” To test this strategy, we assemble AA earnings release dates and WMT earnings release dates since the beginning of 1997 (the earliest available for AA), estimating the date for one missing WMT release. This sample period is more than twice as long as that cited. Using these earnings release dates, daily dividend-adjusted closes for S&P 500 SPDR (SPY) as a proxy for the broad stock market and the daily 13-week Treasury bill (T-bill) yields over the period 2/25/97 through 4/9/11 (60 quarters), we find that:

The average length of the earnings seasons (off-seasons) as defined is 38 (53) calendar days. Over the entire sample period, the average total return for SPY during the 60 (60) earnings seasons (off-seasons) is +0.4% (+1.2%), with standard deviations 5.8% (6.3%). The spread in average returns between earnings seasons and off-seasons for the first (second) half of the sample is 1.2% (0.5%). Rationalizing to account for different durations, the average daily total SPY return during earnings seasons (off-seasons) is 0.008% (0.021%). While the broad stock market does appear to be stronger during the earnings off-season, shorting during earnings season probably loses money on average.

For another perspective, consider three strategies:

1. AA-WMT Long Only is in cash (long SPY) during the earnings season (off-season).
2. AA-WMT Long-Short is short (long) SPY during the earnings season (off-season).
3. Buy-and-Hold SPY is the benchmark.

Trading assumptions are as follows:

• Initial investment in each strategy is $100,000 at the close on 2/25/97.
• Active strategy trades occur at the close on AA/WMT earnings release dates.
• Trading (switching) friction is 0.125% (0.25%) per trade for the AA-WMT Long Only (AA-WMT Long-Short) strategy.
• The return on cash is the T-bill yield.
• Ignore costs of shorting and tax implications of trading.

The following chart compares the cumulative values of $100,000 initial investments in the three strategies based on the above assumptions over the entire sample period. The earnings season strategies generally underperform buy-and-hold, perhaps with tendencies to fall behind during bull markets and catch up during bear markets. The AA-WMT Long-Short strategy is particularly unattractive because of an average gross loss while short and relatively high trading frictions.

With zero trading friction, the cumulative value trajectory of AA-WMT Long Only strategy is very similar to that of buy-and-hold, but the AA-WMT Long-Short strategy still badly underperforms.

For another perspective, we consider seasonal statistics.

The final chart compares average daily returns for the above three strategies, with one standard deviation variability ranges, over the entire sample period. Results indicate that the AA-WMT Long Only strategy captures much of the buy-and-hold performance with relatively low volatility.

Setting trading friction to zero increases the average daily return of the AA-WMT Long Only (AA-WMT Long-Short) strategy to 0.024% (0.012%).

In summary, evidence from simple tests does not support a belief that going to cash or shorting the broad stock market during the earnings off-season reliably beats buy-and-hold. It does support a belief that the market tends to be relatively weak during earnings season.

Cautions regarding findings include:

• Going to some asset other than cash during earnings season may improve performance of the AA-WMT Long Only strategy.
• The sample period is short for subsample analysis.
• To the extent the return distribution is wild rather than tame (normal), average and standard deviation statistics are not reliable expectations.

See “Stock Returns During and Between Earnings Seasons” for results of tests on a different definition of earnings season.

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