With the markets continuing to shrug off negative unemployment news and health uncertainty of re-opening this month, we wanted to take this opportunity to introduce the family of mean reversion factors. Many of you are feeling tense about the recent rally, and are possibly looking to take defensive actions. Mean reversion factors can help highlight companies who’s recent returns (positive and negative) are at the extremes of the entire market. Coupled with fundamental analysis, these factors can be used as indicators to help better time investment decisions.
Axioma’s Short-Term Momentum Factor
In our first post of a multi-part series, we focus our attention this week to Axioma’s Short-Term Momentum (“STM”) factor. It is based on the cumulative return of an asset over the previous 20 days - assets with the highest cumulative return will have the largest positive exposures to this factor, and assets with the lowest cumulative returns will have the largest negative exposures to this factor.
Why is the factor return so negative?
As a security performs extremely well (or poorly) over a 20 day period relative to the entire market, it’s exposure to STM increases. Quantitative traders typically follow this trend and make a bet that the price will revert to normalized levels, often guided by peer stock behavior. Over the past 10-15 years, the percentage of volume of quantitative trading in the markets has risen to levels cited higher than 90%. The more quantitative traders piling up on the mean reversion trade, the more likely it is to fall (or rise) in price. Since the STM factor return represents the return of a portfolio holding thousands of securities, we see that this effect works quite well.
Which Companies are Most Exposed to STM Today?
Let’s focus on the companies in the US market with the highest positive STM exposures today. Below we filtered the Russell 3000 to the securities above $1B in market cap and >$5mm of ADV with exposures in the top 5% of STM. We find a total of 37 securities in the following industries:
Given the COVID environment bouying up vaccine and ventilator makers, work-from-home enabling software companies, and e-commerce companies, we would expect to see Biotech, Software, Internet Retailing, and Healthcare Equipment represented. What’s interesting is that we also see 5 names in the Oil & Gas sector, and singular names spread across insurance, autos, and specialty retailers.
Antero is up 78.63% over the past 20 trading days (1 month):
And we can see that in a space of ~2 weeks, its STM exposure had a massive move from a score of -1 (bottom 33% of the market in returns) to +3.5 (>99% of the market).
As a fundamental investor, if you believe Antero Midstream has rallied to unsustainable valuation levels, its STM exposure will help you align the timing of your sell with your thesis.
US & Global Market Summary
In exciting news, our partners at Axioma have begun publishing weekend model updates, allowing us to provide you with Friday data going forward. After this week, our market and factor summary will shift to cover Monday - Friday model dates.
US Market: 5/1/20 - 5/8/20
Please let us know if you’d like to better understand and manage your exposure to any of the factors that we’ve discussed.