Could the 'Sunshine Effect' Help Your Portfolio?

Individual investors, here's a tip: As you consider investment strategies for next year, you might want to check the weather before you buy a stock on the day it announces earnings. A theory by two accounting professors known as "the sunshine effect" suggests that the price of certain stocks may be prone to move higher than normal when earnings are announced on sunny days.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% Sound silly you say? Well the authors of this research, which was released in the spring, base their findings on several long-standing credible studies that say weather can affect a person's mood and other research about the connection between the stock market and weather patterns. They've just taken those theories and attached them to earnings announcements and trading behavior -- things we know move markets.

The result is the theory that market participants may interpret earnings announcements of stocks traded on exchanges in New York City more favorably on sunny days, thus, if a company reports good earnings news, then the stock price reaction is a little higher than it "should be," and similarly, if bad earnings news resulted, then the stock returns would be a little less lower than they "should be." It should be noted that the exact opposite reaction takes place on rainy or snowy days -- negative earnings produce a more negative result and positive earnings produce a less positive result in the stock price.

John Shon, an assistant professor of accounting and taxation at Fordham University and co-author of the research, suggests, "Investors who spark these reactions are, truly, high on the weather."

Skeptics might suggest that you'd have to be truly high on something other than the feel-good cosmic rays of the sun in order to buy into the theory. In any event, Shon and his co-author, former accounting professor and Neuberger Berman vice president Ping Zhou, say their theory could prove useful, but admits their research isn't a guarantee.

There are a few caveats they warn investors of:

"The sunshine effect" is most applicable for small cap companies without much name recognition -- not large blue chip stocks. Since many small firms aren't followed by market analysts, the likelihood is that more moves are made on speculation (feelings) rather than calculations and by investors who are more naïve about the markets. Mood could play a larger role.

"The big hedge fund and institutional guys don't fall for this [sunshine effect], but it tends to be the small individual investors that do fall for it," Shon said.

The "sunshine effect" only exists for companies traded on the New York Stock Exchange and the American Stock Exchange. "The NASDAQ does not have a physical stock exchange, so it wouldn't make sense to try to correlate NASDAQ-listed stocks with New York City weather," he explains.

Just like the weather, "The sunshine effect" can turn rather quickly. Although stocks may be influenced by sunny days' affect on the markets, "over the next two or three days, the stock price does tend to go back to where it 'should be,'" says Shon. Any over-reaction or under-reaction to the stock price generally reverts back to a more realistic level.

So armed with information that suggests a legitimate pattern, how might investors use "the sunshine effect" to become rainmakers for their own portfolio?

"If there are individual investors who are doing this, you should jump in the next day -- in the opposite direction...," Shon advises.

But be warned because the theory hasn't been proven. Just like trying to predict the weather, trying to predict what stocks will do based on the weather could leave you and your portfolio under water.
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