investing james saft |
Fed watching can be fun and profitable, but investors might want to broaden their focus and become Supreme Court watchers, too.
In an age when most news is a commodity, instantly digested, often by automated traders using algorithms, Supreme Court cases not only move the market, but do it, crucially, with a delay, according to a recent academic study.
A share price movement with both a cause and a delay is an old-fashioned trading opportunity.
“There is typically a significant delay between the release of the Court’s decision and the ultimate price movement,” write researchers from the Illinois Institute of Technology, the University of Michigan and Michigan State.
“For all but a small number of securities in a small number of cases, there is a significant lag in the signal-processing environment. This implies a market ripe for arbitrage where an event-based trading strategy could be successful.”
The scope of the opportunity is reasonably large: The study, which looked at Supreme Court cases from 1999-2014, found 79 that drove statistically significant stock price movements in 118 securities. Just considering the window from the opening bell on the day of the court’s decision until the close of trading the following day, the decisions accounted for an aggregate of $148 billion in stock price movements.
That lag in time between the release of the decision and when the market digests it and prices it into securities is driven by a wide range of factors, including the difficulty of interpreting decisions and the potential for error in reporting.
The study purports to be the first to look at the issue taking into account intraday trading, as opposed to longer-term price changes.
Sometimes, as with the 2012 case National Federation of Independent Business v. Sebelius, which considered aspects of Obamacare, wrong early reporting of a complex verdict can whipsaw stock prices. Fox News and CNN, reporting live from the scene, both initially reported that the individual mandate had been struck down. That caused a number of health care stocks, including Humana and Aetna, to spike upward, moves that were rapidly reversed when a more accurate reading of the decision showed that Obamacare had been upheld.
Interestingly, much of the losses in the health care stocks hit by the decision came only in the second day of trading, after investors had been better able to analyze the implications.
A 2013 case involving the patent claims of Myriad Genetics over cancer screening tests is an interesting counterpoint to the health care case. While the immediate coverage wasn’t wrong, the stock market seized the wrong end of the stick, trading Myriad shares up sharply in the minutes after the ruling. Only later that day did consensus settle that the ruling was highly unfavorable to Myriad, starting a decline that took the stock down 20 percent.
Both cases suggest legal rulings aren’t biased toward or against stock market gains.
The distribution of stock movements is wide, in terms of both size and direction. That’s a contrast to trading around Federal Reserve decisions, which numerous studies have shown are biased toward stock market gains. In other words, you can’t just put on risk ahead of a Supreme Court case, you have to be able to react correctly to the news.
In this way, trading a Supreme Court case is like interpreting an extremely complex set of economic data, one for which no clear consensus exists, or even could be constructed ahead of time.
That makes it much more difficult to devise an automated trading strategy in response to Supreme Court rulings.
While hedge funds and other investors have been reported to employ lawyers and analysts to monitor and report on Supreme Court cases, the lack of a clear black and white consensus in most cases makes this both potentially rewarding and tricky.
Several of the authors of the study have worked on trying to predict Supreme Court decisions using methods like crowdsourced predictions (which have worked well with company earnings) and algorithms.
But Supreme Court cases, dependent as they are on the actions of nine justices and numerous lawyers, may for a long time be an area where only better information, better interpretation and faster execution can lead to profitable trading.
James Saft is a Reuters columnist.