The Incredible Difference in Post-Earnings Trading

How Stocks are Reacting to Earnings

Dear Bottarelli Research Member,

As we kick off a new trading week, everyone wants to know how the Dow will react after posting its biggest weekly gain of the year. So far, the gains have held quite nicely, as the Blue Chip index is only giving back 20 points (as I write).

On the same hand, the intense speculation has officially begun about what the Fed will do on August 8^th. As it stands, economists are giving the possibility of a rate hike a 50/50 chance — although I personally feel that last week’s gains already priced in a rate pause. If the Fed raises rates on August 8^th, we could be in for a sell-off. Because of that, I’d like to take any profits off the table this week as fast as possible. Ideally, we will not be holding a lot of positions come Monday, as we could be in for quite an unpredictable and volatile ride depending on what the Fed says.

As far as today’s news, I’d like to report on Garmin (GRMN – NASDAQ), as the stock is jumping today in front of Wednesday’s earnings report. Although there is no news out, GRMN is up $2.60, a move that has pushed our August 90 Puts (GQR TR) down to $3.70. It looks like speculative investors are buying up shares in advance of their earnings report, but a recent study I came across could reveal the flaw in this thinking.

According to a study in this week’s Barron’s, 73% of companies on the S&P 500 have beaten earnings forecasts (numbers as of July 24^th). This is the highest percentage of positive surprises since the first quarter of 2004. But here’s the interesting part. During this same period, the average one-day share price gain among the positive surprises was a mere 0.13%. This is the weakest reaction to good earnings news in four years!

On the flipside, it’s a totally different story when it comes to earnings disappointments. Of the 10% of companies that have fallen short of expectations, their one-day share price losses have been an average of 3.45%. That’s the worst showing in any quarter since late 2002! What this tells me is that the market definitely has a “sell on news” mentality. It also tells me that the odds are stacked in your favor to be holding puts the day of earnings announcements. With an upside surprise averaging a piddly 0.13% gain and a downside surprise averaging a 3.45% loss, the risk/reward scenario clearly favors the put side. For that reason, I’d like to maintain our GRMN August 90 puts leading into Wednesday’s earnings.

When you look at the stock chart, you see a company that has been on a huge run — but it could be coming to an end. Sure, GRMN occupies the strongest strategic position of anyone in the GPS industry — but they are now facing increased competition from Sony, Phillips, and TomTom. Not only that, but Google is looking to enter the market niche with their new “Google Earth Locator” — which reprograms your wireless network to pick up GPS signals. And heck, you can always print off free door-to-door instructions from Mapquest. For all those reasons, GRMN could report a decline in gross margins come Wednesday, sending the shares lower. This would put our August puts back in the black for a nice gainer, especially if today’s move shows that the 50-day moving average has now been converted from support to resistance.

Of course, there’s always the risk that GRMN blows Wall Street out of the water and sends the stock shooting aggressively higher — but if you look at the facts presented above, the odds of that are slim. Maintain our GRMN August 90 puts.

Lock and load

Sincerely,