Three Gray Swans – Week of July 7 – 11

I think it is safe to say that everyone has heard of black swans and the term is used liberally to describe any sort of sell off in the stock market or other financial market. In reality a black swan is an event that cannot be anticipated. The markets are completely caught off guard and the reaction is a black swan event. When you read in a financial blog something like, “the next employment number may be the black swan that pushes stock prices lower” you are reading a statement that is not accurate. If someone is expecting an event and knows the timing of that event it is not a black swan by definition. To be more succinct, once an event is anticipated or forecasted it really cannot be considered a black swan.

A gray swan is an event that is partially known while a black swan is a complete surprise to the markets. Often the part of the gray swan event that is ‘known’ is the timing. The aspects of the event that are not known are the substance of the information accompanying the event and of course the subsequent market reaction to the event. My goal through this series of blogs is to highlight three ‘gray swan’ events each week that may have an impact on a stock, commodity, or the overall financial market the following week. Next week’s gray swans are earnings for Alcoa (AA) Monday after the market close, the release of the FOMC minutes from the June 17 – 18 meeting on Wednesday afternoon, and earnings for Wells Fargo (WFC) Friday before the market opens.

Alcoa’s Earnings –

Alcoa reports their earnings results for the quarter than ended June 30th on Tuesday July 8th after the market closes. Until recently, AA was always the first stock in the Dow Jones Industrial Average (DJIA) that reported earnings. The financial media likes to refer to AA’s numbers being the official start of earnings season. Although Alcoa is no longer in the DJIA it is still associated with the commencement of earnings season. There are also several studies, including one by me, that try to take AA’s stock reaction as an early indicator of how the overall stock market will fare over the course of earnings season which lasts for two or three weeks (depending on the calendar). The studies are a little more accurate on the bullish side than the bearish side.

AA reported their first quarter 2014 earnings results on April 8, 2014. The stock reaction was a rise of 3.75% based on last quarter’s earnings release. Over the past three years the absolute average move for AA post earnings has been 2.53%. This 2.53% number is important for option traders that like to take positions based on the magnitude of a company’s expected price change. Over the past three years the biggest drop in Alcoa’s stock price was 5.43% while the biggest rise was 6.22%. That 5.43% drop was in January of this year when AA reported their fourth quarter and full year 2013 financial results.

FOMC Minutes –

Now this is an interesting ‘gray swan’ and probably should not be on the list. However, what we learned from some number crunching was pretty darn interesting. Some of the best things in life are about nothing; just ask the cast of Seinfeld who continue to collect royalties for a show about nothing. We found that the market’s reaction to FOMC Minutes is a whole lot of nothing.

Hannah Chody, who is doing an awesome job at the Options Institute as an intern this Summer, did some number crunching on the stock market’s reaction to the periodic release of the FOMC minutes. She first dug into the FOMC’s website and got all the dates of these releases going back to February 2009. Finally, she took a look at the last two hours of trading for days when the FOMC releases the minutes of a previous meeting along with the last two hours of trading for regular old trading days. The result is that, on average, the days the minutes are released the S&P 500 moves 0.33% from the time of the release (1:00 Chicago time) to the close of the day. It also turns out that the average price change for the S&P 500 over the last two hours of trading on any day is also 0.33%. So this release doesn’t really have much of an impact on the markets. This may be our first instance of a white swan – we know something is coming and we know it doesn’t really matter.

Wells Fargo –

Normally both Wells Fargo (WFC) and JP Morgan (JPM) report their earnings on a Friday early in the earnings season process. JPM reports a week later (July 15th) this quarter due to the Independence Day holiday. So this time around WFC is going it alone as the first major financial to report earnings for the second quarter of 2014. As the first big bank to report there will be a lot of attention given to how the second quarter went for Wells Fargo and any forward looking statements that come from management during their conference call. Note that WFC reports before the open, but their conference call is during market hours beginning at 10:00 eastern time.

Last quarter WFC stock rose a whopping 0.78% the day the company reported. This was actually the third quarter in a row that WFC stock moved less than 1% after reporting earnings.   There has been more volatility in the past with the biggest drop being 8.44% and the biggest rise 5.69% in the last three years. Also the average move off earnings over the last three years has been 2.37%.   In addition to Wells Fargo keep an eye on other major financial stocks for any reaction to the news from WFC on Friday.

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Russell Rhoads, CFA

CBOE Options Institute

Russell Rhoads, CFA, is a Senior Instructor with the Options Institute at the Chicago Board Options Exchange. He joined the Institute in 2008 after a career as an investment analyst and trader with a variety of firms including Highland Capital Management, Caldwell & Orkin Investment Counsel, TradeLink Securities and…

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