Bond Rout Is Reviving Quant Value Trade in Best Year Since 2016
Bond Rout Is Reviving Quant Value Trade in Best Year Since 2016
(Bloomberg) -- A rout across the bond market is fueling a comeback for risky stock strategies as traders ride the economic reopening in the grip of the energy crunch.
As Treasury yields march higher for a fourth day, a market-neutral trade that goes long value stocks and shorts their more-expensive peers is set for another strong performance after posting the best gain since March on Monday.
Adding to the momentum: Surging oil prices are boosting companies in the energy sector that tend to fall into the cheap and cyclical bracket.
While U.S. equity benchmarks are red across the board on Tuesday, contracts on the Russell 2000 Index of smaller, riskier companies are faring better than those on the rate-sensitive Nasdaq.
“Value is important not just because of its relative cheapness to other stocks, but also due to its ability to make money when bond yields are on the rise,” Societe Generale SA quants led by Andrew Lapthorne wrote in a note this week.
The fresh sign of confidence in riskier stocks comes as the yield on 10-year U.S. Treasuries hits the highest since June. That’s a sign investors see a robust economic recovery overcoming fears of new covid variants and supply-chain issues. Traders are favoring cyclically exposed shares that can ride the upswing, and with rates potentially rising they prefer the near-term cash flows of such companies.
It’s a potential replay of the first quarter, when the Dow Jones U.S. Thematic Market Neutral Value Index surged. The strategy has been stop-start since then, but the bond selloff looks poised to revive the gauge. Now up 11% this year, it’s set for the first annual gain since 2016.
The Treasury selloff that first kicked off after the Federal Reserve meeting last week is deepening after a two-year auction saw weak demand, spurring a further equity rotation across global markets.
As well as value and small stocks benefitting, Goldman Sachs Group Inc. baskets show that the most leveraged U.S. companies just had their best day relative to healthy balance sheet names in six months.
The recovery of value in particular is a boon to quantitative investors like AQR Capital Management’s Cliff Asness and Research Affiliates’ Rob Arnott, who have both recently preached persistence in the factor even as it lost money over the past two quarters.
While cheap stocks bottomed out in late 2020, they’re still cheaper than at least 97% of the time in data going back decades, pointing to ample room for gains, Arnott wrote just last week.
The AQR Equity Market Neutral Fund had its best day since July on Monday. Among the three factors that guide that fund, Dow Jones indexes show value’s surge more than made up for a drop for quality and a flat performance for momentum.
Meanwhile, traders sold protective puts and bought bullish calls Monday on both the iShares Russell 2000 exchange-traded fund (ticker IWM) and the Energy Select Sector SPDR Fund (XLE), according to Chris Murphy, the co-head of derivatives strategy at Susquehanna. That’s a sign of increasingly bullish sentiment.
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