Earnings` Season and the Indian Stock Market!

The past rally on the D-Street comes as a pleasant surprise to all the traders and much to their relief. However, the global & domestic factors which had pulled down the market in the past few months continue to bother the markets. In fact they have worsened with the Japanese Crisis, Middle East Unrest and the slowly springing European Debt Crisis (Portugal, Greece Downgrade).

So, what really is helping the market to rally? It is the Earnings season, which is around the corner. However, there`s a logic behind the rally fuelled by this earnings` season. In this post we try and decipher how this seasonality occurs and how it should be handled.

The pre-Earnings Season speculation usually kicks off with the filing of the Advance Taxes. The Advance Tax numbers hit the markets on the 15^th March`2011 (or a bit earlier), when the markets were lingering around 18300 levels and since then we have had a run up with the markets rising by nearly 1200 points, a whopping gain of 6%. !!!

The Institutional Investors like various mutual fund houses and other analysts are the parties who could justify this rally.These entities, based on data sources like Order books, Advance Tax payments, Historical Earning trends, etc, forecast the earnings of various companies for the quarter. Based on their forecast, they go long on the stocks. These estimates, more often than not, are accurate. And also as the market picks up the buzz, long positions start building around these stocks. In other words, their anticipation/speculation builds around the stock and this leads to a rally.

However, these institutional investors tend to liquidate their positions just before or after; the markets get to know the numbers. This, results in a follow on rally on the day of the results.

This span of 2 -3 sessions, is the point where the retail investors get glued to the stocks and hope for the rally to continue, which never occurs.

Unless the estimates beat the street by a good amount, the markets generally don`t tend to continue the streak.In fact, it has been observed over the years, that the markets usually tend to correct post the earnings season, which can be viewed as a good entry point for a long term investor.

In the third quarter of FY10, the pre-earnings bounce in IT stocks was evident. Tech Mahindra gained 8.5 per cent against Sensex's 3 per cent gain in the one month before the earnings season. TCS jumped 12 per cent, Wipro 11 per cent and Infosys 9.4 per cent. This trend was maintained in six out of 10 quarters — cementing the hypothesis.

Post-earnings weakness was evident in the third quarter (Oct-Dec) of 2010 as well. Infosys fell 8 per cent in one month after its results, TCS shed 5 per cent, Wipro 12 per cent, HCL Tech 6 per cent while Tech Mahindra and Patni Com­puters lost between 11 per cent and 12 per cent, dwarfing 7 per cent fall in Sensex during the same period. The same trend was more or less repeated in 2008, 2007, and 2006.

So, as a retail investor, who normally picks up the stock buzz late, is advised to avoid buying stocks after a pre-seasons rally, if he intends to be invested for long. This would just mean that he would buy the stocks at unjustified levels. It is always a good idea to buy a month before the earnings season, when the markets would be at good support levels. To be more specific, one can invest in stocks in the 1^st week of December, March, June & September.

Having understood the impact of the Earning season would help in making an informed choice. However,stock picking is no mean task, which reminds me of a Mark Twain quote,i.e. “October is the most dangerous month to speculate on stocks…” He quips that,” …the others are July, January, September, April, November, May, March, June, December, August, and February."