Identifying Alpha Opportunities Driven By Non-Fundamental Moves

First off, we hope that you and your loved ones remain healthy and safe, wherever you may be isolating during these difficult and troubling times.

Today we examine the current state of the market and how there may be some benefit from a stock picking perspective.

Synopsis of How Major Factors Have Moved in March 2020

Market turbulence spurred by the COVID-19 outbreak has pressed many factors to multiples far outside of their historical averages. To illustrate this dispersion, the table below lists 12 of the most common style factors used by investors and ranks them based on the number of standard deviations that last month’s performance represented compared to their 10-year average (Jan 2010 – Jan 2020).

If we highlight a few of the factors that typically see minimal month-to-month movement, we see that Profitability sits at the top of the list with a 7.2x standard deviation. Profitability is typically referred to as the ‘Quality’ factor and comprises quality-related metrics such as return-on-equity, return-on-assets, cash flow to assets, cash flow to income, gross margin, and sales-to-assets. It’s abundantly clear that investors have been flocking in droves to quality names.

Not at all dissimilar to what occurred during the Financial Markets Crisis of 2008, investors have been dumping Leverage. Leverage is composed of metrics related to total debt-to-total assets and total debt-to-equity and is a factor that moves glacially in a normal market environment. It ended down 3.44% last month, which actually represented a pull-back as its nadir for the month was -4.13%. Investors are seeing highly levered companies as much riskier than normal in the current environment.

Investors are flocking to larger market cap names (Size) and are punishing companies that have supply and distribution chains more exposed to global foreign exchange movements (Exchange Rate Sensitivity). We plan on doing a deeper dive into recent movements in the Exchange Rate Sensitivity Factor in next week’s Factor Spotlight.

These large factor moves may present prime buying opportunities for investors who have seen certain stocks move largely for non-fundamental reasons.

‍But what are some practical methods that you can use to measure the factor effect?

Factor Movements that are Creating Investment Opportunities in the Current Market

As the markets exhibit less and less rational behaviors, a golden opportunity may be in store for investors who track recent factor movements. When looking at their particular universe of stocks, investors should ask themselves, how much of recent moves are fundamentally-driven, and how much are non-fundamental? This environment seems ripe with potential arbitrage opportunities that they can dig deeper into.

Using Omega Point, below we will go through three examples of individual stocks that represent various sides of the factor opportunity spectrum:

‍Moderna (MRNA)

Moderna is a biotechnology company focused on drug discovery and drug development. In January, Moderna announced the development of a vaccine to inhibit COVID-19 coronavirus with a subsequent announcement of an ETA in 2021. If you look more closely at its recent performance, it’s clear that the most significant component of this stock’s move is related to alpha, and much less so for irrational, non-fundamental reasons. Investors using this type of factor-based lens to uncover opportunities should probably skip Moderna and look at other names in their universe.

‍Avis Budget Group (AVIS)

Avis represents a more middle-of-the-road example based on a mix of factors and alpha driving its recent movement. Approximately 50% of its move has been related to fundamental factors, while the other half is alpha related. This makes sense, as Avis is in an especially difficult situation right now based on the global travel environment that impacts its core business. Some further analysis may be in order for Avis, but better opportunities may lie with names barely being driven by alpha.

‍Dupont (D)

As shown above, Dupont is down over 20% in March but what interests us most here is that 95% of that movement is purely factor related. If we hone in on the sidebar, we can see the breakout of the different factor components. While the market and sector moves seem plausible, there is a 10% downward movement in style factors that may represent significant upside once the factor effect is neutralized. Dupont’s price has been driven almost entirely by factors (i.e. non-fundamentals) and may be a strong candidate for a buy if you agree the move is largely for non-fundamental reasons.

There may be several names in your coverage universe that share the factor characteristics of a Dupont, but we also need to remind readers that investors shouldn’t necessarily take this type of analysis at face value. It’s still an imperfect science, but can give investors a powerful punch list of ideas which they can pursue.

‍Identifying Good Buy Candidates in Your Portfolio

The table above sorts a group of stocks by the impact of factors vs. their total overall return. Names higher on the list such as Dupont exhibit returns that are much less fundamental, and may warrant additional research by you and your team.

Coupled with a strong fundamental story, a likely good bet in the long term:

• A buy: large negative factor move as a percentage of the total move
• A sell: large positive factor move as a percentage of the total move

We encourage you to look at your own portfolios and highlight names that look like they have moved for non-fundamental reasons. If you would like to have Omega Point help you perform a similar analysis, please reach out to us.

US & Global Market Summary

US Market: 3/27/20 - 4/02/20

• The market ended the week sharply lower, with the S&P 500 losing another 1.51% on Friday (not captured in above chart). Much of the negative performance was driven by dismal employment metrics as the impact of COVID-19 has started to show up in the data.
• On Friday, the March jobs report showed a loss of 701k jobs in March - far worse than consensus worst-case scenarios. This represented the first decline in payrolls since Sept 2010 and was close to matching the worst month of job losses during the GFC.
• Even more concerning was Thursday’s jobless report, with first time unemployment applicants increasing by 6.6 million in the most recent week, essentially hitting 10 million over the past two weeks.
• Oil futures saw double digit gains on Friday as Saudi Arabia, Russia and several other major producers are expected to negotiate production cuts early next week.
• The IHS Markit U.S. Services PMI came out at 39.8, the steepest decline that it’s seen since inception.
• After trading barbs over the week, McConnell and Pelosi have both stated that another federal aid package is in the works.

‍Factor Update: Axioma US Equity Risk Model (AXUS4-MH)

• Market Sensitivity continued its sharp rebound, up +0.82 standard deviations in the last week and approaching neutral territory. Remember, this factor just hit a trough of -3.45 SD below the mean on 3/18.
• Earnings Yield saw a big move on a normalized basis and is now essentially a neutral factor.
• Value remained on a path of reversion back towards the mean, exiting Extremely Oversold space and now sitting at -1.64 SD below the mean.
• After a tough month, Growth saw slight positive normalized gains and shed its Extremely Oversold designation, for now.
• After a period of brief respite, Volatility declined on a normalized basis and looks poised to re-enter Oversold territory.
• Size continued to fall from a peak of +3.2 SD above the mean on 3/18 to +1.91 SD above the mean, leaving Extremely Overbought territory.
• After a meteoric rise, Profitability hit a peak of +6.47 standard deviations above the mean on 3/20 and has continued to revert back towards the mean, now sitting at +4.38 SD above the mean.
• US Total Risk (using the Russell 3000 as proxy) saw an increase of +0.29%, far less than what we’ve seen in past weeks.

‍Factor Update: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• Market Sensitivity continued last week’s strong positive trend, exiting Extremely Oversold territory and now sitting at -1.3 SD below the mean.
• Volatility also left Extremely Oversold space and now sits at -1.58 SD below the mean.
• Earnings Yield saw a +0.45 SD move and earned an Extremely Overbought label at +2.08 SD above the mean.
• Unlike the US, Profitability continued to see strength and remains close to +4 SD above the mean.
• Value also continued to recovery internationally, and is close to exiting Oversold territory.
• Exchange Rate Sensitivity, which measures a stock’s sensitivity to a basket containing USD, EUR, GBP, JPY, continued its decline, albeit at a slower pace after falling over 3 standard deviations last week after the $2.2T stimulus bill was announced.
• Size started to revert worldwide, similar to what we saw in the US last week, and remains Extremely Overbought at +3.29 SD above the mean.
• Global Risk (using the ACWI as proxy) remained essentially flat after the massive gaps up we’ve witnessed in the past month .

Regards,
Omer