Barclays Quant Commentary: Worst Returns Environment For Disciplined Stock Pickers In 60 Years

Tyler Durden's picture Submitted by Tyler Durden on 10/11/2010 09:41 -0500

BarclaysMatt RothmanMomoPIMCOShort InterestValue Investing

We present another great review of market dynamics from the eyes of a quant, this time coming yet again Barclays’ Matt Rothman. With Risk On, Risk Off the dominant regime since QE2 speculation, and likely to last into the end of the year, throw away all fundamental textbooks, and focus on what it is the momo machines are chasing. Which is simple: to outperform in this market, load up on high beta stocks and high short interest names. The rest is noise. Which means a bloodbath for “disciplined stock pickers” – as Rothman says “the investment managers who are suffering are the truly disciplined stock pickers. Those managers who are diligent about having no style tilts or theme tilts or sector biases are finding it nearly impossible to generate returns. There are no investment opportunities returns for these managers to capitalize on. There are no idiosyncratic  returns available in the market for them and the situation has, essentially, never been worse, anytime in the past 60 years.” Then again, there are no traditional stock pickers left anymore – everyone now does the same as Pimco – stay one step of the Fed (and just imitate what everyone else is doing), or risk losing your job. In the meantime the biggest groupthink trade ever is getting bigger by the day, as everyone hopes and prays profit taking never occurs.

Market Commentary from Matt Rothman of Barclays:

It has become utterly cliché to state the market is oscillating back and forth between a “risk-on” and “risk-off” stance, but we think the characterization is apt and can’t think of a better way to put it. As the broad market averages surged approximately 9% this month, investors piled in to seemingly riskier stocks and portions of the market.

One way to see this is through examining high beta stocks versus low beta stocks and high short-interest stocks versus low short-interest stocks. At the beginning of the month, we created a series of five portfolios according to a stocks beta and another independent series of five portfolios according short interest outstanding. As shown in Figure 2 below, there is a strictly uniform increasing relation between a stock’s return this month and its beta – the higher its beta, the higher its return. Likewise, we see the same type of relation between a stock’s level of short interest at the beginning of the month and its return over the month – the higher its level of short interest, the higher its return.

The riskier the stock (e.g. the higher its beta), the better its return was this month. The greater the investor skepticism and the more negative the sentiment surrounding a name at the beginning of the month (e.g., the higher its short interest), the better a stock’s return was in September. It was that simple.

We saw the same theme manifest itself in our quantitative theme portfolios as well. Low quality stocks beat high quality stocks this month by -1.45%. Companies with lower ROICs outperformed companies with higher ROICs. Companies that were increasing their debt (relative to assets) levels bested those that were shrinking their debt levels. Companies with lower relative net margins rallied past companies with higher relative net margins. On most of the common measures of Quality, the lower ranked the company, the better its returns this month.

This also translated into lower priced (cheaper) companies beating higher priced (expensive) companies. To the extent that cheap companies were cheap for a reason, investors seemingly put those concerns behind them and bid up the prices of these stocks. Companies with lower Book-to-Price and Sales-to-Price ratios handily outperformed their relative cohorts. Investors choose to put the past in the rearview mirror, deeming it insignificant, offering no clues to the future, instead focusing solely on Forward Earnings to Price and Earnings Revisions. Similarly, Price Momentum failed to be an effective factor as well as trailing returns are, well, history. What did the stock do over the past 9 months? Investors answered with a resounding “Who Cares!” as prior losers beat prior winners.

This single-minded focus on macro (or thematic) investing is also manifest in the persistently high level of correlation across stocks. As shown in Figure 3 below, while the level of correlation across stocks in the Russell 1000 has retreated from its historic levels of May and June, it still remains elevated.

As we have written in the past, low levels of stock dispersion generally correspond with difficulty in picking individual stocks. For as stocks movements increasingly coincide, the unique individual components of a stock’s story tend to shrink in importance and the common and systemic (macro) factors gain in importance. As macro-economic factors dominate a market, how a stock is exposed to those factors will become the principal determinant of that stock’s return.

However, one break in the trend that we are beginning to see is that the dispersion in some sectors is beginning to increase. In particular, within the Energy, Consumer Staples, Technology and Telecomm sectors, we are beginning to see correlation break down. Within these sectors we are beginning to see a return to stock picking (see Figure 4 below).

We have taken our analysis of correlation still one step further to understand the sources of the high correlation. Specifically, we break down the sources of common factor variation into three component parts: (1) sectors; (2) fundamental factors; and (3) macro factors. Fundamental factors include our sector neutral valuation theme, sector neutral quality theme and our sector neutral sentiment theme, along with market capitalization, and a sector neutral leverage factor. Macro factors are the first two principal components of the residuals after controlling for sectors and factors. We classify the remaining residual as the idiosyncratic or unexplainable portion of returns.

As we show in Figure 5, the proportion of correlation that is being driven by the idiosyncratic component of returns is currently very near zero. Almost all of the correlation is being driven by common factors – there is effectively nothing left over. Indeed the only times that the proportion of the idiosyncratic component was lower was in October 1987 and May/June 1962.

For investment managers who are investing according to their beliefs regarding the greater macroeconomic cycle, this is obviously the type of environment they like. So it is also, for managers who invest according to themes (or quantitative factors). Quality investing and value investing and trend following investing can still pay off; after all, it is not as if the returns to our quantitative themes have been zero over the past several months.

The investment managers who are suffering are the truly disciplined stock pickers. Those managers who are diligent about having no style tilts or theme tilts or sector biases are finding it nearly impossible to generate returns. There are no investment opportunities returns for these managers to capitalize on. There are no idiosyncratic returns available in the market for them and the situation has, essentially, never been worse, anytime in the past 60 years.

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by Racer
on Mon, 10/11/2010 – 09:46
#640777

When everyone is thinking it will never go down and all on the same side of the trade.. like oil at $135….

 

Login or register to post comments by redpill
on Mon, 10/11/2010 – 09:48
#640780

There’s only one “stock” to pick, and that’s frontrunning the Fed whenever and however.

Instead of lamenting the decline of stock pickers like a whining journalist waxing poetic about the good old days of investigative reporting, why not take the opportunity to focus on the fact that central banking/planning destroys the market’s capability for price discovery and upsets the fair valuation process for every company.

Login or register to post comments by Tyler Durden
on Mon, 10/11/2010 – 09:52
#640786

It appears you may have missed the past 20,000 posts on Zero Hedge. Today is a slow news day – a good time to catch up.

Login or register to post comments by Mercury
on Mon, 10/11/2010 – 10:21
#640839

It’s not exactly unrelated.  Because of central banking/planning, alpha is dead in this market.  Or at least micro alpha is dead – a.k.a “price discovery and…the fair valuation process for every company.”

Login or register to post comments by Chemba
on Mon, 10/11/2010 – 09:50
#640782

This is such a sad and pathetic situation.  Banana Ben and his Board of Fed Lackeys are almost single-handedly destroying the capital markets.  How the Fu#$ can he not see what he is doing to this country?  Capital formation is not going to happen in this environment.  Savers are ruined.  Investors and businesses want no part of Banana Ben’s Banana Republic.  Fu$% Bernanke:  Arrest him.  He is a criminal.

Login or register to post comments by SheepDog-One
on Mon, 10/11/2010 – 09:56
#640795

Its utterly pathetic, now we’re supposed to wait until December for the FED to deliver its gifts to the banksters, from us, as we have to sit thru daily headlines such as todays Yahoo!Finance ‘Stock Rise on Renewed Hopes FED Does Something’. WTF

Login or register to post comments by AccreditedEYE
on Mon, 10/11/2010 – 10:19
#640855

Chemba, did Lloyd fire you for spilling coffee on his lap? I’m sure the Squid is well positioned to make massive gains after it tells the Fed what they need to do on the 3rd.

PS- Newsflash: Capital formation has been on the decline in this country for years now. The way is shut… it was made by TPTB and TPTB keep it. The way is shut.

Login or register to post comments by count_de_monee
on Mon, 10/11/2010 – 09:52
#640787

In case no one is watching, I’d like to let the ZH community know that the political situation in Portugal is very tense at the moment. The current government has been in power for over 5 years and is increasingly weak and scandal ridden (check out this youtube video where an english businessman admits to bribing the current PM http://www.youtube.com/watch?v=2nmIcGdlZiM). The increasingly desperate government has a slim majority that is not enough to pass any of the announced austerity measures. Furthermore, there is a massive general strike being planned for early November in a country where over 60% of the population either works for the government or is dependent on government subsidies to survive.

But the real clincher is that the largest opposition party, the PSD, has so far refused to help the govt pass the austerity budget which is due to be voted on the 29th of October.

Without their support (see this article http://dn.sapo.pt/inicio/portugal/interior.aspx?content_id=1682921 in today’s Diario de Noticias where the leader of the opposition says he will not vote favorably no matter how much pressure they put on him), the PM has already said he will resign. Throw in the fact that Portugal has presidential elections in early January which means parliament cannot be dissolved until spring 2011 at the earliest, and you have an explosive cocktail that most news outlets are either ignoring or know little about.

This could be the event that gets the default ball rolling again.

Login or register to post comments by TumblingDice
on Mon, 10/11/2010 – 10:13
#640802

Indeed the only times that the proportion of the idiosyncratic component was lower was in October 1987 and May/June 1962.

Back then it was the stock market that crashed; this time it’s the dollar. Just goes to show that panic works both ways.

Login or register to post comments by wiskeyrunner
on Mon, 10/11/2010 – 09:58
#640803

The insiders of the exchanges love these HFT guys they generate a lot of commissions. They would love for everyone to make millions of transactions daily. The exchange will even give you a spot below the main trading floor to hook up your mainframe so you too can get closer to the action.

I have an Apple Mac Pro can I play?

Login or register to post comments by michigan independant
on Mon, 10/11/2010 – 09:58
#640807

Indeed, thank you for for the conveyance.

“dispersion in some sectors is beginning to increase”

I agree with that evidence in emerging market funds. Since structual issue remain IMO.  

 

Login or register to post comments by fatdaz
on Mon, 10/11/2010 – 10:02
#640813

I hate to disagree but we are stock pickers and over the last four months I have averaged a 64/65% hit rate. Indeed I had a 73% sucess rate in september. We look at FTSE 350 and Top 300 European names play long or short as required & look for  3% a trade  and move on ,we use stop losses to preserve capital. We have  technical model as a frame work  &  stock selection process is discretionary/ overlayed with  technicals -its not easy t get it right but it is possible. to provide some context I  have made 77 recomendations in the last four months.

Login or register to post comments by matthylland
on Mon, 10/11/2010 – 10:20
#640860

I think you may be missing the point though.

The point is not that one can not make money buying and selling stocks, but that fundamentals mean nothing.

What is your return vs. general market? What is your return vs. high beta names such as aapl, amzn, etc etc….?

 

The fact that you have been succesful is great, I wish I had that %…but there is a big difference between calling yourself a stock picker in this environment and just a buyer who is riding the wave. (Not that that is a bad thing, whatever gets you money).

 

Login or register to post comments by AccreditedEYE
on Mon, 10/11/2010 – 10:24
#640867

What is your return vs. general market? What is your return vs. high beta names such as aapl, amzn, etc etc….?

And what about currency devaluation? (Unless you hedged…)

Login or register to post comments by gwar5
on Mon, 10/11/2010 – 10:07
#640824

Fed bubble. This one is intervention on steroids.

You know what they say about bubbles –it just takes a prick.

Login or register to post comments by BobWatNorCal
on Mon, 10/11/2010 – 10:14
#640841

“…everyone hopes and prays profit taking never occurs.”
It will.
I’m buying popcorn now in anticipation.

Login or register to post comments by Lucius Corneliu…
on Mon, 10/11/2010 – 10:20
#640857

As a small investor, I’ll just wait for the envitable fire to break out in the casino.  When the market realizes that monetizing a mere $1Trillion will do nothing but make bread and fuel more expensive, look out below!

Login or register to post comments by kaiserhoff
on Mon, 10/11/2010 – 10:28
#640880

That’s what we’re seeing, isn’t it?  Only Baldy Ben thinks there is some connection between the big banks and simpler things, like employment and small business.

Login or register to post comments by SheepDog-One
on Mon, 10/11/2010 – 10:25
#640870

Oh no, now the headline has been changed from ‘Stocks up Nicely on Renewed Hopes the FED Does Something’ to ‘Stocks Struggle in ‘Mixed Trading’ Amid Hopes the Fed Does Something’.

How long must we sit thru this daily clown show?

Login or register to post comments by SheepDog-One
on Mon, 10/11/2010 – 10:26
#640873

BTW, why does the FED have to do something anyway? I thought the common knowledge was the economy is recovering swiftly? Hmmm, maybe not so much?

Login or register to post comments by SheepDog-One
on Mon, 10/11/2010 – 10:28
#640881

So now the FED and Gooberment has to in effect admit to 2 years of lying, while saying the first thing they did was a complete failure, but now obviously the solution is to do the exact same thing again except this time with far more Q/E? Its NOT a position I’d want to be in!

Login or register to post comments by HarryWanger
on Mon, 10/11/2010 – 10:31
#640888

Unless you were fortunate enough to get into some huge winners, I’d agree. However, THE most solid company on the planet is up about 60% this year. Apple alone has saved many “investors” since it’s held by just about everyone. And with no competition to really speak of yet, it probably has another 30-40% return through 2011.

Neither high beta or a stock with big short interest, people tend to overlook a fundamentally strong company with a stock price to reflect that. It’s the way all stocks should be. Investing in a company with great management and innovation with growth. It’s still possible. 

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