HomeBusiness DigestDo stock prices react to news?

Do stock prices react to news?

DURING the year 2010, the stock market has been retreating, albeit slowly. However, there have been marginal gains in various stocks especially on the penny stocks. Volatility on the stock market has been experienced in comparison to the more serene money market which maintained constant rates of return during the year. 

As though awakening from slumber, after a prolonged period of drift in the month of October the Equities market was characterised by a bullish stock market and suppressed money market rates. This bull-run was to be short-lived as trend reversal commenced in the first week of November.

To the investor, the question which may be asked is what triggered these reversals in gains? Is it the trend that in the month of November investors shed off their portfolios in preparation for vacations, or is there any news that has triggered the retreat of the stock market, and if so, when do we expect the equities market to stabilise?

Over the past decade, there has been a large amount of evidence that stock prices are predictable, regardless of the base currency being used. For example, during the lost decade (1998 – 2008), stock prices would rise in line with inflation thus predictable.

Some research shows that stock prices appear to drift after important corporate events for several months.

This suggests that drift (stock price fluctuation) is driven by underreaction to information. In under-reacting, investors and analysts undershoot, and by showing little enthusiasm are slow to investing resulting in the late investing bird missing the market worm. When news / events are signalling an important change of prospects (for the whole market or for a given stock), investors usually under-react, they do not rush to make a move.

Evidence shows that security prices underreact to news such as earnings announcements. If the news is good, prices keep trending up after the initial positive reaction; if the news is bad, prices keep trending down after initial negative reaction.

This underreaction was depicted by the initial rise in the Econet share price from US$4,40 as the corporate was set to release its half year financial results, where investors expected a dividend. This news drove the share upwards until after the semi–annual results were published, however the update was slow. Sensing that the news was not as anticipated, the share price peaked at US$5,15 before retreating to the current US$4,80 levels.

It would have been expected that with the recent launch of more value added products by Econet, high levels of share update would be exhibited.

Similarly, the growth strategy of Delta should have seen increased volumes of trade on its counter and an increase in its price. Causes of underreaction vary and may include and are not limited to the lack of knowledge to appreciate the relevancy of new information, and anchoring on old facts, on ingrained beliefs, on old estimates, and on previous experiences.

Sometimes investors fail to react at all. In general, in the short term, investors underreact, followed by gradual adjustment, and then overreact in the long term.

There are many days though when financial markets move dramatically, but without any apparent economic news. In this circumstance there will be “excess volatility” in the asset prices. This suggests that investors overreact to unobserved stimuli.

Once the cascade of news and of market reactions fully infiltrates the market, investors, and above all non professionals tend to over-react in their exuberance or fright. Sometimes it can even reach the point in which people think that the new market behaviour indicates what is the new paradigm valid for all eternity. They start to prove it by elaborating totally new “scientific” explanations to find rationality in the irrational.

When investors overreact to price movements they trade more than they should. This is easily seen by the volumes traded currently as investors are uncertain of the future given the impending elections and news that the current Government of National Unity (GNU) has serious challenges. We further anticipate increases in sales volumes and this also increases stock price volatility.

In conclusion, most of the research on stock returns after specific news items supports the idea of underreaction, which is defined as average post-event abnormal returns of the same sign as event date returns (abnormal or raw). The main examples include signalling events and scheduled news releases, like in the likelihood of the elections being conducted in June 2011 what happens next? As evidenced by the retreat on the ZSE Investors also seem to be slow to react to capital structure changes. So yes, we may conclude that indeed stock prices react to news.

Byron Manuhwa is a Zimbabwe National Chamber of Commerce macroeconomics sub-committee member

Recent Posts

Stories you will enjoy

Recommended reading