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In financial storm, stocks move with lightning speed

Published Sep. 13, 2005

There hasn't been a one-day crash in the stock market in years, but one-day crashes in individual stocks have become frighteningly routine.

It now takes little more than a day, and often less, for investors to pound a stock down dramatically when bad earnings news is released, compared with the several weeks that were typical in the 1980s, a new report shows. Stocks also rally much more rapidly on good news.

The trend to much faster stock reaction, which many investors have long suspected, has been fed by faster information flow and a proliferation of hedge funds and so-called momentum investors _ investors who rapidly move in and out of stocks based on how fast earnings, sales or stock prices are moving.

That's a big reason why investors are paying increasingly rich valuations for big, blue-chip growth companies with a track record of not disappointing. They're afraid of being caught holding a "torpedo" stock, that is, a stock that can blow a huge hole in an otherwise solid portfolio.

Robert Butman, president of TQA Investors LLC, a New York hedge fund, looked at how thousands of stocks react to worse-than-expected earnings (negative surprises) and better-than-expected earnings (positive surprises) from 1995 to 1998, then compared that with an earlier study of similar reactions from 1983 to 1989.

In both periods, the stock price on average fell about 8 percent relative to Standard & Poor's 500-stock index on a negative surprise. That means that if the S&P 500 dropped 2 percent in that period, the stock fell 10 percent. But while that drop usually took three to four weeks in the 1980s, it now occurs within two days. Similarly, with positive surprises, stocks typically gained 8 percent between three and four weeks after the report in the 1980s, but in the 1990s, it took less than three days.

"The impact of news events is being absorbed by the market almost instantaneously," says Butman, who used data and methodology supplied by DAIS Group.

That sudden and powerful impact is one reason companies try so hard to manage investors' expectations. And those management techniques are working: While the companies in the S&P 500 to report so far had first-quarter profit growth of a measly 3.3 percent, the reported profits were still 2.9 percent above analysts' much-reduced estimates, according to First Call Corp. The "better-than-reduced-expectations" reports helped drive stock prices to records last week before Friday's pullback.

There are several explanations for the much more rapid response of stock prices to news. One is improved technology, which speeds release of earnings news and analysis.

Another factor is the size of positions investors now trade, said Jamie Atwell, head of Nasdaq trading for growth-fund manager Nicholas-Applegate Capital Management. Fund managers now typically own 1-million shares of a company instead of 10,000, he says. So a manager trying to get in or out of a stock moves its price far more.

Finally, there are thousands of hedge funds now that trade instantly on news. Though they may only trade 5,000 or 10,000 shares, enough of them together will move the price quickly, Atwell says.

The past few weeks have seen several instances of this phenomenon. One of the most notable was when Cendant Corp. said after the market closed April 15 that it had discovered "potential accounting irregularities" in its core membership-club operations which would reduce 1997 earnings and hurt this year's earnings. The next morning, the stock opened on the New York Stock Exchange at $18.75, down 48 percent from the previous day's lose of $35.62{. It closed at $19.06\ with more than $14-billion lopped off its market capitalization.

Volume often soars on such events, but a lot of the trading is driven by hedge funds and rapid-fire "day traders" trying to make a quick buck. Georgeson & Co., a New York shareholder analysis firm, estimates that on most days, about 50 percent of a large-capitalization stock's volume is accounted for by people who buy and sell within the same day. But on occasions when volume spikes dramatically, that share soars to 75 percent to 90 percent.

Stocks move so quickly it's often impossible for an investor to act on news before it's fully reflected in the price. Some try to anyway, which has given rise to much more after-hours and pre-opening trading.

Atwell, for example, says he will buy or sell before the regular market opening if news makes it necessary. "My job is to out-trade my competition and to hopefully be the first one pulling the trigger."