I have a saying that when there is no news, the market reveals its true direction. That applies to individual securities as well as the market as a whole. Why?
Think of institutional traders, who drive much of the market. They are so big that they have to spread out their orders over time, or they would move the market against their positions. On days when there is no news, volume tends to be light, displaying the actions of the big traders.
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Valero Energy Corporation (NYSE:VLO) recently spun off CST Brands Inc (NYSE:CST), which was their retailing arm, selling gasoline, and things you find at convenience stores. Seems cheap to me. Over the last few days it has been rising on no news. To me that means some institutional investors are buying.
I’ve seen the same thing happen when a stock falls on no news. That’s usually a bad sign if you are long, because it means someone is selling for a reason you are not aware of. Now, if you have done your homework, and know more than the seller, a lower price is to you advantage if you want to buy more. The trouble is, you don’t know how much the seller has to unload. To use CST Brands as an example again, I received some shares as a result of holding Valero Energy Corporation (NYSE:VLO) for clients (and me, I get what my clients get), but I estimated how much index related selling had to happen as a result. I bought a full stake for my clients at the point where the total volume from the prior “when issued” trading, plus actual trading on the first day hit my estimates. It was close to the low for the day, though someone more enterprising could have picked up shares cheaper during the “when issued” trading, if he was clever.
But sometimes when there is news, you need to try to gauge whether something is an over- or under-reaction. My favorite example here is Reinsurance Group of America Inc (NYSE:RGA), the prominent well-run life reinsurer. Once every eight quarters or so, they report a lousy quarter. Why? Because of the law of small numbers. The large claims inside a life reinsurer are few, but make a considerable difference to the earnings when a bunch of large policy deaths happen at the same time. The general public does not get this, so when RGA has a bad quarter, it is usually a good time to be a buyer.
The same applies to P&C reinsurers during crises. I added to my reinsurance holdings post-Sandy, because I knew that the reinsurers would take relatively few claims because they don’t cover flood for residential, though they might have commercial-related claims. As it was, none of my insurance holdings had any significant claims from Sandy, and the portfolio did well.
Toss out another example, but Endurance Specialty Holdings Ltd. (NYSE:ENH) is one of the leading underwriters of crop insurance. Crop insurance was a horrible place to be last year, and that put pressure on ENH as a stock. But that neglected all of the other lines of business of Endurance that were performing well, as well as the risk controls that Endurance placed on its crop insurance business.
Perhaps the broad message here is to know your stocks well, so well that you can gauge whether a market reaction to news is overdone, underdone, or meh, normal.
Analyzing the reaction to news (or no news) bonds and other assets as well. When I was an institutional bond manager, I would watch the results of trading on the slow days, because it would give a clue to what the “big guys” were doing. Also, when an event that has been anticipated occurs, like a ratings downgrade on the bonds of a troubled company, the market reaction says a lot, because often there are many who were waiting to buy once the downgrade happened, so price rises a lot at the downgrade. (Think of the USA downgrade by S&P.) The reverse is true for downgrades that are more of a surprise.
In summary, all news is not equal. The reactions to news, and the lack thereof, can tell us a lot about the intentions of large market actors. Do your homework well, and prosper off of the knowledge that it gives you regarding reactions, over-reactions, and under-reactions.
Full disclosure: long VLO CST RGA ENH
By David Merkel, CFA of Aleph Blog