If recent history has any relevance to the upcoming (and much anticipated) earnings announcement on April 24th from Apple (AAPL), odds favor a very positive reaction the following day.
I generally prefer to ascertain the best response to a post-earnings reaction since the news is known at that time - for example, see post-earnings strategies for Amazon.com and Best Buy (click the links). However, in AAPL's case, the strong and persistent selling ahead of earnings caught my attention. I simply could not recall such obvious negativity ahead of any recent AAPL earnings report.
It turns out that this selling is indeed the worst in recent years. Apple's average daily price change over the past two weeks is -1.1%. This is the WORST pre-earnings performance for AAPL over the past five years. In fact, AAPL has only performed poorly five other times out of a total of 21 earnings cycles since 2007.
Apple's Average Daily Price Change During the Two Weeks Prior to Earnings Since 2007
The daily chart below reminds us that the current selling remains a drop in the bucket compared to AAPL's year-to-date run-up (not to mention the longer-term upward trend). However, the current downtrend during April is quite pronounced and has driven Apple into an important test of presumed support at the 50-day moving average (DMA). It even looks as if the $600 "tripwire", or psychological price point, is failing to support AAPL. The large selling volume adds an exclamation mark to this trading action.
Apple is now testing critical support as pre-earnings selling accelerates
It almost seems obvious that a large segment of traders and investors are dreading Apple's coming earnings report and want to get out of the way ahead of time. Ironically, this same negativity is likely creating a buying opportunity and paving the way for a post-earnings rally. First of all, since 2007, Apple's stock has tended to respond positively to earnings. Out of 21 earnings cycles, Apple has ended the day following earnings with positive gains 15 times. Moreover, AAPL has tended to deliver substantial one-day post-earnings gains. (All earnings calls during this time period occurred after the close of trading).
Distribution of One-Day Price Changes After Apple Reports Earnings (Jan, 2007 to Jan, 2012)
The x-axis labels describe a range of price performance. The lower point of the range is not included while the upper point of the range is included. For example, (2 to 4]% represents all price changes from 2 to 4%, excluding 2%.
Even when I break out the analysis by quarters, this current earnings cycle comes up roses. Since 2007, every single April report has delivered a positive post-earnings reaction.
Number of Positive Versus Negative One-Day Reactions to Apple's Earnings By Month of the Year (Since 2007)
I find it VERY interesting that the reaction to Apple's earnings gets less positive as the year wears on. The January report is the first report of the fiscal year. I would have expected it to be easier for Apple to dazzle starting in January. Instead, the high point is April and the relative frequency of positive responses goes down from there.
Now it seems like these data are sufficient to get the pre-earnings bullish juices flowing. Surprisingly, the "fun with numbers" does not end here. It turns out that AAPL's one-day post-earnings performance is, fortuitously, inversely correlated with the stock's 2-week pre-earnings performance as measured by the average daily price change. This inverse relationship has been getting stronger in recent earnings cycles. In other words, the worse Apple performs two-weeks prior to earnings, the better the stock tends to perform the day after earnings (or the better Apple performs ahead of earnings, the worse it tends to perform the day after earnings)…and this relationship has been slowly getting more reliable in recent earnings cycles. I checked the correlations for the 1-week and 1-day prior to earnings to confirm that the 2-week period is indeed special.
Correlation of Apple's 2-Week Average Daily Pre-Earnings Price Change to the One-Day Post-Earnings Price Change
To interpret this chart, note that the x-axis represents the earliest year for measuring correlations. For example, at 2011, the -0.83 correlation covers the five earnings cycles starting with January, 2011. It suggests that the worse Apple performs in the two weeks prior to earnings, as measured by average daily price change, the better Apple performs the day after earnings (or again the better Apple performs ahead of earnings, the worse it tends to perform the day after earnings). The chart shows that including 2007 or 2008 in this calculation destroys the relationship; that is, the correlation is particularly poor in those years. With a focus on more recent years, the strong relationship shows up, and it has grown stronger in recent cycles. Even the last four earnings cycles are slightly stronger than the last five in aggregate. Correlation ranges from -1 to 1 where -1 is perfect inverse correlation, 1 is perfect direct correlation, and 0 is "perfect" non-correlation.
The inverse correlation with Apple's 1-week average daily price change is relatively strong but nowhere near the convincing pattern created by the 2-week average daily price change. The correlation between the day before and the day after earnings is particularly uninformative.
Correlation of Apple's 1-Week Average Daily Pre-Earnings Price Change to the One-Day Post-Earnings Price Change
Correlation of Apple's 1-Day Pre-Earnings Price Change to the One-Day Post-Earnings Price Change
Data sources for all bar charts: Earnings dates from briefing.com; AAPL stock prices from Yahoo! Finance
I am guessing that since Apple's stock is dominated by institutional investors and traders, event-driven trades must play out over many days ahead of the event. Large holders must start early to avoid overwhelming trading on any given day as well as ensure they have enough time to complete the trade given the uncertainty of liquidity on any given day ahead of the event. Apple was trading at all-time highs two weeks ago: anyone scared of Apple's earnings got the best possible selling point.
So, putting it all together, odds strongly favor a positive reaction to Apple's earnings on April 24th. The current selling is likely a buying opportunity. Even if Apple surprises and tanks after earnings, I strongly suspect that, barring extremely awful news, subsequent selling will be treated as potentially the last chance to get in Apple sub-600 for some time to come. After all, to-date, buying Apple on almost any given day has generated profits for almost everyone willing to hold onto the stock today.
StockTwits provides a heatmap that definitively confirms how closely investors and traders are watching Apple and discussing Apple. Technology dominates the tweets that are sent through StockTwits via the "$" preceding a stock ticker. Apple grabs the lion's share of attention in technology. I am sure this heatmap will get even more distorted toward Apple and tech as earnings approaches and unfolds.
Click for larger image…
Be careful out there!
Additional disclosure: I am long an AAPL call spread