Heard Off the Street: Market sensitive to latest headlines

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If push came to shove and people were forced to identify Mario Draghi, they might guess he is a Pavarotti wannabe or an Italian Olympic swimmer.

After last week, more of them should be able to provide the correct answer.

Reassurances from Mr. Draghi, the silver-tongued president of the European Central Bank, that the euro's last line of defense will do whatever it takes to save the currency -- and that the bank has the wherewithal for the job -- sent Wall Street sharply higher Thursday. The S&P 500 and Dow Jones industrial average rose 1.7 percent on the Italian banker's soothing remarks.

The advance came despite the fact that similarly encouraging news on the euro front in the past has oftentimes led buyer's remorse and more sober assessments of prospects.

The development illustrates two facts of life that more long-term oriented investors have to contend with: Volatility makes the market more vulnerable to short-term news that may or may not have long-term meaning; and well-heeled funds that make a living by trading on short-term news can cause sharp, often irrational gyrations.

"They just have the ability to move the market with the amount of money they're dealing with," said Matt Yanni of Yanni & Associates, a Franklin Park investment advisor.

Consider the plight of Chipotle Mexican Grill [ticker: CMG] after the Denver-based restaurant operator's 21 percent increase in second-quarter sales failed to impress analysts. In what some pundits are referring to as a burrito bubble, Chipotle shares fell nearly $90, or 22 percent, July 20. They finished Friday at $296.08, off $20.90 for the week.

What happened Friday after Starbucks [SBUX] registered disappointing earnings and issued a downbeat outlook was mild by comparison. Shares of the coffee merchant slid 9 percent to close at $47.47, friending Facebook [FB] on the way down. Quarterly results that were not up to snuff caused the social network operator's share to slide 12 percent Friday, closing at $23.71. That leaves it down 38 percent from the $38 per share initial public offering price.

Most companies being punished over earnings are high beta stocks. Beta is a measure of a stock's volatility in comparison to the broader market. The higher the beta, the more the stock's performance will diverge from the broad market, on the upside as well as the downside.

Traders focusing on short-term strategies gravitate to high beta stocks. Included in that category are momentum stocks such as companies expected to deliver above-market earnings growth.

"All the stocks that got whacked were the momentum stocks," said Greg Melvin, chief investment officer for C.S. McKee, Downtown.

The volatility is not coming from retail investors. Those who have not put all their chips into bond funds prefer stock mutual funds. When they buy individual stocks, they tend to be buy-and-hold investors. The swings are fueled by hedge funds and private institutional traders whose strategies include placing short-term bets on whether quarterly earnings will move a stock.

"That's all the investor is interested in, capturing some of that move," said John Frankola of Vista Investment Management in Pittsburgh.

Mr. Frankola said short sellers who bet against stocks also account for some of the swings. Shorts borrow shares they do not own and sell them on the hunch that the share price will go down. If it does, they repay the loan by buying shares at a lower price.

If they are right, that can trigger a wave of selling. If they are wrong and have to buy shares at a higher price, that can attract other buyers and boost the stock price.

Ronald Heakins of OakTree Investment Advisors in Shadyside said some of the volatility can be traced to high frequency traders who use computer-based models to capture gains measured in pennies. But they trade so often that the pennies turn into real money.

"They keep buying and buying until the models tell them to start selling," he said.

That's when markets can turn on a dime.

Although many traders exploit headlines for trading gains, the headlines often do not convey what the future holds. While analysts were encouraged by Mr. Draghi's promise to do "whatever it takes," those three carefully scripted words did not change their long-term outlook on how the euro crisis will play out.

"I don't think the European situation is much different than it was three months ago, six months ago or even a year ago," Mr. Frankola said.

It's not the first time investors have overreacted to developments on the euro front.

"What was extracted in the headlines immediately was a generous interpretation of what he said," according to Kenneth Orchard, a London-based sovereign credit analyst for T. Rowe Price.

He noted that the optimism follows a significant sell-off based on euro fears "that was probably an exaggeration as well."

"There have been a lot of announcements, comments, newspaper headlines over the last two years that have caused temporary blips on the market," Mr. Orchard said.

Erratic price moves do not make investing any easier for investors anchored by a long-term strategy. For them, the challenge is divining the future from a 24-hour stream of daily headlines that, in and of themselves, may not mean all that much.

bizopinion

Len Boselovic: lboselovic@post-gazette.com or 412-263-1941.


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