Over the past couple of weeks, we've examined Growth and Profitability to see the impact that 1Q earnings have had within the Russell 1000. We've now incorporated two more fundamental factors in our analysis - Value and Earnings Yield - to identify 21 companies that have had positive or negative fundamental changes in the past month that the market hasn't priced in yet. These names may be interesting trade opportunities if they do indeed represent a market imbalance.
First, let's start with a review of the past week's market and factor action:
US Market (5/3/19 - 5/9/19)
All three major indices saw their worst weekly declines in 2019 as US - China trade tensions dominated headlines. On Friday (not captured in above chart), stocks recovered after taking early losses to end mostly higher based on indications that negotiations with China following new tariffs were “constructive.” Investors will look to next week for earnings for Walmart and Macy's, as well as economic data on retail sales, industrial production, and consumer sentiment.
Here's an update on how some key factors (and US Total Risk) have changed in the US model over the past week, using our normalized return indicator.
- Size factor saw a significant 1-week decline, falling over one full standard deviation to -0.47 standard deviations below the mean. Size recently peaked at +1.51 SD above the mean on 4/16, suggesting large caps have rapidly fallen out of favor as of late.
- Growth saw the biggest gap up, going from being perfectly neutral in our normalized framework to +0.41 SD above the mean.
- Volatility and Market Sensitivity both saw a continuation of last week's trend, slightly up on a normalized basis and trending away from Oversold territory.
- After declining at a decent clip over the past few months, US total risk (using the Russell 3000 as proxy) ticked up mid-week during the market selloff and is now essentially flat from where it was a week ago.
1Q Earnings - Adding Value and Earnings Yield to the Mix
As fundamental investors, we typically look to capitalize on opportunities where underlying company fundamentals have changed, but the market has yet to price the changes in on a relative value basis. This week, we'll show how the Omega Point platform can find attractive trade candidates by identifying names that have shown improving or declining Growth and Profitability scores where the expected changes to relative value haven't occurred. We'll be using observations of concurrent changes in Value and Earnings Yield exposure to identify these candidates.
To wit: if a company saw improving Growth and Profitability scores but their Value and Earnings Yield exposures didn't fall, it would appear the market hasn't priced in that fundamental improvement (as investors haven't bid shares up in kind). Conversely, if a company saw deteriorating fundamentals but valuation hasn't taken a hit yet, the stock may represent a good sell or short opportunity.
As a reminder, Value is based on Book-to-Price, while Earnings Yield is a blend of realized and forecasted Earnings-to-Price.
- Take two dates that span the bulk of Q1 Earnings Season - in this case, 4/1/19 and 5/9/19
- Identify companies in the Russell 1000 with simultaneous same-direction changes in Growth or Profitability z-score (x > 0.1 or x < -0.1) between those dates, suggesting that fundamentals are improving or deteriorating, respectively.
- Filter those companies for those where the respective deltas in Value and EY z-scores are as follows:
- For positive changes in Growth & Profitability, the delta in Value and EY is > = 0 (price hasn't increased relative to improving fundamentals).
- For negative changes in Growth & Profitability, the delta in Value and EY is < = 0 (price hasn't decreased relative to the deteriorating fundamentals).
Potential Buys - Improved Fundamentals, No Increase in Relative Valuation
In every case, we can see that exposures to Value and Earnings Yield actually increasedat the same time that their Growth and Profitability metrics did. It's notable that many of these names come from the insurance or biotech industries. One name that sticks out is SMG, which saw a gap up in Profitability while also seeing a sizable increase in Value exposure.
Potential Sells - Deteriorating Fundamentals, No Decrease in Relative Valuation
Here, most names saw a decrease in Value (meaning their multiple went up on a relative basis) at the same time that Growth and Profitability were being negatively re-rated. In a couple of instances (YUM and TEAM), their relative Value remained flat during this period, which makes for slightly less low-hanging fruit. ARD stands out as a name that had massively negative fundamentals and a simultaneous relative increase in valuation.
Naturally, we'll want to dig into the news around these names before assuming that each one is a true market imbalance vs. a beneficiary (or victim) of a company-specific datapoint. In both of these cases, no news is truly good news. If company fundamentals are quietly improving/deteriorating but the market hasn't made any noise around it - then there could be a pure stock-picking opportunity.
Next week, we'll take a look at how Value and Earnings Yield exposures have changed at the Industry Group (GIC 2) level during 1Q earnings to see if there are any valuable insights to find. If you'd like to discuss this dynamic further, or learn more about your portfolio's relationship to factors, please don't hesitate to reach out.