Quants in Late-Cycle Angst as Value Sees Crisis-Era Funk
A U.S. long-short value portfolio, an investing style typically deployed by quantitative funds, fell for 10 consecutive days through Wednesday, the longest losing run on record. That defies the market’s prediction for a stellar trajectory for value stocks -- those priced cheaply relative to their assets -- amid record profit forecasts for Corporate America and continued expansion in Europe.
If sustained, it’s a troubling signal about the growth trajectory, and defies Wall Street projections at the start of the year. Strategists reckoned cheap equities would finally outperform growth stocks, as a spirited uptick in global output redresses their undervaluation.
Instead, as managers like DoubleLine Capital’s Jeffrey Gundlach call for a peak in economic momentum, investors continue to gravitate towards companies like Netflix Inc. and Amazon.com Inc -- growth stocks that can gin up profits independent of the economic backdrop.
“The main issue is that at this stage in the cycle -- late-stage expansion -- it is not supportive of the factor,” said Inigo Fraser-Jenkins, who leads Sanford C. Bernstein’s global quantitative strategy team. “Value has already come into the year with unusually high analyst revisions, so there’s little scope for further upgrades.”
There was a glimmer of hope early April as momentum -- which bets on shares with the best one-year performance -- began to slump, and value looked poised to pick up the slack. That quickly fizzled out. As of Wednesday close, a market-neutral value portfolio in Europe has seen its worst two-week decline in nearly two years, while the U.S. version has fallen the most since March 2009, according to data compiled by Bloomberg.
Those with the stomach to ride through the sector’s underperformance may be rewarded. Investor appetite for cyclical stocks like value could yet return as consumption, investment and trading flows juice corporate earnings.
And undervalued companies typically benefit in a rising rate regime as they produce strong cash flows, boosting their appeal as low-duration assets, while growth stocks offer the promise of earnings in the future, the thinking goes.
“Value underperformance could continue for longer, but at some point it’ll have to turn," said Yazann Romahi, chief investment officer of quant-beta strategies at JPMorgan Asset Management, which manages $1.7 trillion in total.
For now, that’s little solace for quants that incorporate value into their funds. Take the Credit Suisse Liquid Alternative Beta index, which tracks a multitude of investing styles to reflect the performance of hedge funds. It’s fallen about 1.4 percent this year, on track for the biggest losses since 2008.
Though it posted gains on Thursday, U.S. value is still headed for a weekly dip, the second-worst performing factor among 10 tracked by Bloomberg.
And value’s recent plunge comes at a risky time. The Morgan Stanley developed market cycle indicator, which measures the health of the economy, the credit market and corporates, is nearing levels last seen just before prior recessions.
More clients project America is gripped in the late winter of its expansion, according to Bernstein strategists. While most consider the euro area less mature than it’s U.S. counterpart, the firm sees the region as being on the cusp of a slowdown and recommends reducing value exposure.
JPMorgan’s Romahi, for one, is keeping the faith that the factor will recover soon enough.
“Value is like a coiled spring -- you have a drawdown that could continue for a while, but then you get it back. The difficulty is saying when that could happen."
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