Identifying Crowded Names — Q1 2021 Earnings Season

Crowding metrics come in several flavors, but by and large, act as indications to fundamental investors that they may be holding names that are highly susceptible to market dynamics that may be outside of the purview of the investor. The Momentum crash of Sept 2019, the COVID downturn (and subsequent Beta rally) of March 2020, and the most recent “Vaccine Monday” Momentum crash of Nov 2020 are all eye-opening examples of what can happen when market dynamics take over and crowded names get hit hard.

With this in mind, and given we’ll soon be in the full swing of Q1 2021 earnings season, this week we’ll be providing insights on crowded names to watch for and more importantly, how to make that crowdedness work in your favor.

Isolating the Riskiest Crowded Names

To define crowding, we’ll leverage the Wolfe Research QES US Broad (“Wolfe QES US”) risk model’s Hedge Fund Crowding and Short Interest factor exposures. The definitions of these factors are:

• Hedge Fund Crowding - measures the sensitivity of a stock to a long/short basket constructed using hedge fund intensity (% of float) and level (market value) based on 13F filings.
• Short Interest - measures the sensitivity of a stock to a long/short basket constructed using the ratio of shares borrowed for shorting to inventory available for lending.

Names with high exposure to the HF Crowding & Short Interest factors point to names that may be crowded on the long & short side of the market, respectively.

In past quarterly crowding updates, we’ve incorporated a filter for idiosyncratic risk in order to identify names that are more susceptible to the “earnings pop” after they report; however, recent analyses (see our posts on “Where’s the Alpha” in 2018/2019 and 2020) show that the current levels of alpha-driven stocks (i.e. stocks with idiosyncratic risk > 67%) are extremely low relative to 2018, 2019, and early 2020. As such, an idiosyncratic risk filter proved to be a too stringent criteria for the current environment.

Instead, we have approached the problem a bit differently and attempted to identify names that are susceptible to downside pressure (for the long crowded names) or upward pressure resulting in a short squeeze (for the short crowded names) after positive or negative earnings surprise. These are likely the names that pose high risk to the portfolio and/or (depending on your view) offer an opportunity to exploit the stock’s fundamentals or volatility post-earnings.

To pinpoint these securities, we leveraged the Revisions factor from the Wolfe QES US risk model, which measures analyst revisions in mean consensus EPS and Sales over the next 12 months. High positive exposure to this factor points to names that are expected to beat their earnings guidance and conversely, high negative exposure highlights names that are expected to miss on earnings.

We’ll be using Omega Point’s Security Search tool to find names within the Russell 3000 that exhibit the above crowding and revisions characteristics. To form the long crowding group, we limited the universe to all securities with HF Crowding and Revisions factor exposures greater than 1. Similarly, to form the short crowding group, we limited the universe to all securities with Short Interest exposure greater than 1 and Revisions exposure less than -1. We also applied liquidity and size filters for average daily trading volume greater than $5M and market capitalization greater than $500M.

The filters above resulted in a long crowding group of 128 names across 10 sectors and a short crowding group of 111 names across all 11 sectors.

The tables below highlights the top 3 crowded names in each sector in the long and short crowding groups.

What To Do With Crowded Names?

There are a few clear choices to address these crowded names.

1. Reduce the position in the name
2. Take a directional bet on the stock price
3. Take a directional bet on the stock volatility

The first (and obvious) choice is to simply stay away from these names. If the fundamental conviction on the name is not strong enough to justify the risk in the security given the crowding characteristics, the best option may be to reduce or remove the position.

The second choice, not for the faint of heart, is to double down on the stock. If your fundamental conviction on the name is very strong, you may want to prefer to stick with your current position or even increase the position.

The third choice may be valuable if you want exposure to the stock, but don’t necessarily want to take on the downside risk that comes with direct exposure to the stock. Here, one alternative is to make a volatility play using options. A long straddle on names with relatively low implied volatility allows investors to take advantage of low priced options that will payoff as long as the volatility of the name increases post-earnings. Given we’ve identified names that have a high likelihood of downward or upward price pressure due to their crowding and revisions characteristics, this could be fruitful method to exploit the stock’s potential earnings exposure to stock without having to take a stance on the directionality of the price movement.

For this third route, the MSCI Barra US Total Market Equity Trading risk model offers a way to find good straddle opportunities using the Residual Volatility factor, which incorporates implied volatility of the stock into the exposure calculation. We applied a filter of Residual Volatility exposure less than 0 to our long and short crowding stock groups, resulting in about 45 names in each group that are contenders for the suggested options strategy. The table below shows the names with the lowest Residual Volatility exposure within the crowding groups across sectors.

No matter how you choose to mitigate the crowding and earnings risk in your portfolios, it’s clear that screening techniques similar to those detailed above can add a valuable lens to fundamental perspectives going into earnings season. Unique factor data that identifies crowding trends can give investors an edge and allow them to avoid detrimental blind spots in the portfolio.

US & Global Market Summary

US Market: 01/18/21 - 01/22/21

• Stocks gained during this historic inauguration week but wobbled on Friday with the S&P 500 and Dow pulling back as COVID-19 concerns resurged and questions arose over whether more substantial stimulus would be passed in the near-term.
• Investors were encouraged by a solid start to the corporate earnings season, with companies including Netflix and Morgan Stanley reporting better-than-expected results.
• New economic data on Thursday, which showed that new weekly jobless claims came in at historically elevated 900,000 last week, underscored the economic toll of the pandemic following the last $900 billion stimulus package.
• The American Association of Individual Investors survey reported the bull-bear spread was at 19.3% versus a median of 4% as of Dec. 31.
• Over 100 companies are scheduled to report quarterly results next week including several major technology-driven companies, including Facebook, Apple and Tesla.

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

• Momentum sits atop the US leaderboard once again for an unprecedented 7th consecutive week.
• Earnings Yield continues its march upward and now sits on the cusp of positive territory after gaining for the 5th straight week.
• Profitability and Growth show strong movement once again.
• Value leveled off after finally showing some pop last week.
• Volatility continues its recent freefall sliding further into negative territory.
• Market Sensitivity finishes as this week’s biggest loser once again and shows little signs of abating.
• US Total Risk (using the Russell 3000 as proxy) decreased by 27bps.

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

• Similar to the US model but with an added twist, for the 7th week in a row both Growth and Momentumfinished the week in the two top spots on the global leaderboard.
• Profitability showed positive movement for the 3rd straight week rounding out the upward movers.
• Volatility and Size continue to show weakness, extending their stay in the negative territory.
• Market Sensitivity continues to show weakness and pushes aside Exchange Rate Sensitivity to finish as this week’s biggest loser.
• Global Risk (using the ACWI as proxy) decreased by 33bps.

Regards,
Alyx