Such are market reactions to fundamental news

I remember when I was just beginning my investment career, I was often confused about market reactions to company news. One day, a company would comfortably beat earnings expectations and the share price would rise substantially. Then the next day or a few days later another company would beat earnings expectations just as comfortably and the share price would decline. In the financial press, you would then read explanations that pointed to a bottom-line beat but a decline in margins or an unexpected increase in costs to justify the share price decline.

Unfortunately, though, in most instances, these are explanations after the fact. If you had asked the analysts giving this explanation on the day before the release how the share price should react to they would have predicted the stock to rise. The reasons given for the realised decline are simply made up after the fact, while in truth, the answer should be that investors just weren’t in a good mood today and thus didn’t bid up the price of the shares. But that explanation goes down like a lead balloon on Bloomberg TV and CNBC. 

But the truth is that in most circumstances (that is except when a company reports truly surprising results) it comes down to market sentiment. Using the sentiment of the Wall Street Journal’s “Abreast of the Market” articles on a daily basis, a study looked at the reaction of share prices to fundamental news like dividend announcements. 

On days with positive sentiment share prices react strongly and in the expected way to the news (e.g. an increase in dividends leads to a rising share price). But on days with neutral or negative sentiment, there was no correlation between the company news and the share price reaction. Sometimes the share price would rise in response to good news, sometimes it would fall and there was no telling which way it would go.

This brings us to the obvious question if there is a way to “forecast” investor sentiment on the day of the data release. A good candidate would be the state of the economy or the market overall. However, the study also found that the sentiment expressed in media articles about the market is largely uncorrelated to the actual state of the economy. Whether the US as in a recession or not explained only 5% of the variation in the tone of media articles. What really drives the sentiment in these media articles are all kinds of unrelated things, from the weather to political news, to personal news that affects the mood of the journalist writing the story. And this mood of the journalists is reflected in the finished article, which in turn sets the mood in the market for the day. In the end, if the share price rises or falls in reaction to good news is a matter of luck, and it isn’t worth pretending otherwise or looking for rational explanations afterwards.