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A reader asks:
"CNBC's Fast Money cited a 'seasonal' strategy noted 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 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 proposition we assemble the earnings release dates for Wal-Mart and the earnings release dates for Alcoa since the beginning of 1997 (the earliest available from Alcoa's web site). We estimated the date for one missing Wal-Mart release. This sample of 45 quarters is nearly twice as large as that cited on Fast Money, potentially offering more reliable historical inference. Using these earnings release dates and daily closing S&P 500 index levels (as a proxy for the broad stock market) over the period 2/25/97 through 4/7/08, we find that...
We assume the trading strategy goes long (short) the S&P 500 index at the close on Wal-Mart (Alcoa) earnings release dates over the entire sample period. The average length of the long (short) portions of the trading strategy is 53 (54) calendar days. Ignoring trading costs, the average return on the index during the 45 long (short) periods is +1.4% (+0.1%), with standard deviation 5.8% (5.3%). The broad stock market does appear to be stronger outside of earnings season than during earnings season.
However, these results indicate that shorting during earnings seasons would not be profitable on average. This variance from the results reported on Fast Money is likely an artifact of different sample periods with different proportions of bear market activity. In other words, the earnings season trading strategy tends to outperform (underperform) the market during bear (bull) markets at least partly because it is short half the time. The starting point for the results cited by Fast Money is favorable to the earnings season strategy.
In our test, shifting to a money market fund or selling covered call options at the beginning of earnings season would outperform shorting. However, trading costs/frictions might offset any net outperformance over buying and holding the index.
As a separate test, the following chart compares the cumulative values of one dollar initial investments in the earnings season trading strategy and a benchmark buy-and-hold strategy. It shows that the earnings season strategy generally lags the performance of buy-and-hold. As noted, the earnings season strategy tends to fall behind (catch up) during bull (bear) market periods.
In summary, evidence does not support a belief that a strategy of going long (short) the broad stock market outside of (during) earnings season reliably beats, or even matches, a buy-and-hold strategy. It does support a belief that the market tends to be relatively weak during earnings season.
For related research, see Blog Synthesis: Calendar Effects.
