Quant Trade of the Decade Slammed for Pricing 25% Profit Growth

(Bloomberg) -- The top high-flying U.S. stocks started this quarter priced for profit growth of a staggering 25% every year for the next decade, according to the latest research from QMA, the $123 billion quant shop at PGIM. The actual rate over the past five years was more like 12%.

It’s giving fresh ammunition to investors who’ve been riding the rotation from growth to value equities since the summer, especially with cheap shares projecting a 4% pace of profit expansion -- below their historical norm.

“There’s going to be a lot of disappointment” for investors in growth shares, Stacie Mintz, a fund manager at QMA, said in an interview in London. “Once that realization starts to hit the market, you’re going to see more of a rotation out of those growth stocks with these really high implied growth rates into these cheaper stocks.”

It’s a conviction which is increasingly gaining traction. An MSCI index of U.S. companies expected to increase profits and sales at a fast pace has underperformed cheap equities -- and the overall market -- since August. That’s after the growth cohort reached the highest valuation versus value shares since the dot-com bubble.

The sentiment shift coincided with an unfolding drama at shared office space provider WeWork, which scrapped an IPO as doubts about its valuation and business model spooked investors. The nervousness spread, and there were sell-offs in companies such as Uber Technologies Inc. and Beyond Meat Inc. as shareholders re-examined their sky-high expectations for various tech darlings.

Quants like Mintz trade stocks based on market-wide metrics rather than bottom-up analysis. As the tech world lost some of its profits-be-damned swagger, a macro shift was underway which may have compounded the rotation effect: Bond yields rose, meaning future cash flows were discounted at a higher rate. That makes it harder to justify rich valuations.

Being long U.S. tech and growth stocks was the most-crowded trade among 178 fund managers overseeing $574 billion, according to Bank of America Merrill Lynch’s latest global survey. But for years now angst over valuations has stalked this bull market, which has been powered by growth mega-caps such as Amazon.com Inc. and Facebook Inc.

For Mintz, it’s a matter of valuations -- the spread between growth and value has room to narrow. That’s why QMA has been increasing the weight of value stocks in its portfolios over the past year.

“You can’t declare victory or declare a trend this fast, but we’re definitely seeing some sort of a change,” she said. “It feels like any little incremental positive news is really helping these stocks that have really been beaten down.”

To contact the reporter on this story: Justina Lee in London at jlee1489@bloomberg.net

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Sid Verma

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