Suppose the U.S. Supreme Court announced a ruling on a given morning that seemed certain to have a market impact for specific identifiable publicly listed corporations. A question of obvious importance for alpha seekers then arises: how much time will have to pass before the consequences of the decision can be said to be fully reflected in the price of the stock of those corporations?
Consider, for example, the case of Altria Group v, Good (2008).
I’ve included the image of a rocky lighthouse-adorned shore with this blog post because this decision arose over Maine’s product labeling laws, which are tougher than those enacted by the U.S. Congress. Stephanie Good and others filed a lawsuit in federal court but relying in part on Maine’s laws arguing that the packaging had deceived them into the belief that “light” cigarettes are harmless. The U.S. district court granted summary judgment to the corporate defendants on the state law issues, holding that the state law claims had been pre-empted by federal regulation in the field. But both in the appellate court and then decisively in SCOTUS, Good won out over evil, uh, I mean, over the tobacco companies.
What Happened Next
Presumably news that states can in fact make tougher labeling standards stick was bad for tobacco stocks. Did stocks immediately adjust downward on the morning of the announcement of this decision? Or did the market turn out to have a learning curve while participants read and figure out the decision, such that a fast reader (or someone who has studied up on the issue in advance) can get ahead of the curve and make a profit?
That is the question addressed by Daniel Martin Katz of the Illinois Institute of Technology – Chicago Kent College of Law, and three colleagues, in a new paper.
Their answer is encouraging. No, contrary to what extreme versions of the efficiency thesis might predict, there is no reason to believe that the opinion is instantly discounted; or discounted too quickly for nimble traders to profit. This is philosophically plausible. After all, such news is eventually discounted because nimble traders have profited, in a process that has to take place within time, in the simple sense in which everything that happens to human beings happens within time.
But it is always good to have empirical back-up for such intuitions. In their paper, “Law on the Market?,” Katz et al show that on the day of the court’s announcement (December 15, 2008) the stock of Altria “trended down, followed by lateral trading for much of the balance of the date of decision,” then continued to decline (relative to the S&P) through the following day, too, “as the financial implications of the Court’s decision began to become more widely understood.”
Thus, short sellers had time to benefit, if they figured out those implications quickly. Altria “experienced a negative cumulative abnormal return of nearly 9%” over the two day window.
A rational market could anticipate a likely opinion, of course. But that leaves open the possibility of a surprise. If the market believed on the day before the decision that there was a 60/40 shot the decision would come out the way Altria wanted, we would expect a priori that the market would have discounted 40% of the possible damage. That would leave a 60% discounting for the next day, or next two days, as the case may be.
Credit Where It’s Due
By the same probabilistic reasoning, even if the market got it right in an anticipatory discounting, the discount would almost certainly have been for less than 100% of the loss at stake, so there would be further discounting to be done after the announcement.
In addition to Katz, the team responsible for the scholarly take on post-announcement moves included Michael J. Bommarito of the Center for the Study of Complex Systems, University of Michigan, Tyler Soellinger, of Michigan State University College of Law, and James Ming Chen, also of MSU Law.
We at AllAboutAlpha are reluctant to blow our own horns. Nonetheless, the study does seem to vindicate the close attention we have paid to decisions pending before the Supreme Court, as well as of decisions announced.