Coffee and Volatility in the Morning

Coffee and Volatility in the Morning

We are now in the middle of ?earnings season? which is one of four times per year when most U.S. companies report their quarterly results. Wall Street has a fun little game we get to play during this time called ?beat or miss?. In this game, companies that don't do as well as Wall Street analysts predicted are usually greeted with relentless selling of their shares. Companies that meet or exceed earnings estimates may go up, down, or sideways depending on what they say about the future. If you have ever sat down with your morning coffee and flipped on the stock market channel to view the horror of seeing one of your stock holdings experiencing a double digit decline in one day, most likely you were a victim of the earnings game. While we aren't sure who still uses Wall Street research after the debacles of the 1990's, it appears that there are still sufficient investors who do.

This is one of the major reasons we began investing with Exchange Traded Funds (ETFs) several years ago. ETFs are baskets of stocks or bonds that track specific broad indices, sectors, and industries. Rarely, if ever, does an ETF face a double digit decline in one week, let alone one day, even though one or more of the components is taking a beating. Sure, ETFs can and do decline ? just nowhere near as much as an individual stock can. For example, Yahoo recently reported earnings and projections that displeased Wall Street. The stock of the company dropped almost 22% in one day. The I-shares Global Technology ETF, of which Yahoo is a component, was actually up on that day. This is one of many examples of how diversifying company specific risk can help investors avoid the ?blowup of the day.?

We frequently address risk instead of returns in this column because it is very difficult to make up severe losses. In order to recoup a 50% loss, an investor must earn 100% on that money. Regardless of what the stock experts on TV say, doubling money is not an easy task to say the least. It is much easier to cut losses before they get too large and look for greener pastures.

Wall Street loves playing the earnings game, but most of us should stick to golf or tennis where the rules are clear.