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Wall Street Races to Figure Out If the Quant Stock Shock Is Over

Wall Street Races to Figure Out If the Quant Stock Shock Is Over

(Bloomberg) -- For the math wizards of Wall Street, it was a once-in-a-decade stock rotation that at one point conjured memories of the pre-crisis “quant quake.” Now systematic investors are butting heads over what comes next.

The sudden plunge of this year’s winning stocks and resurgence of the losers is the start of a trend, according to the likes of Bank of America Corp., JPMorgan Chase & Co., Jefferies Inc. and PanAgora Asset Management Inc. They argue the conditions that preceded it -- a relentless surge of so-called momentum shares versus their value peers -- went too far as investors charged into defensive names.

Yet for naysayers including Evercore ISI and Goldman Sachs Group Inc., the recent reversal was little more than short-covering in a business cycle in the winter of its expansion.

A sudden revival of animal spirits is behind all the soul-searching. That sent momentum shares to their worst week since 2009, and the value factor to its best in the same period, according to Bloomberg indexes. In a sign of the violent stock moves lashing quants, as of late Tuesday morning in New York momentum was headed for its best day since 2011, while value was down.

At issue is the fate of billions of dollars tracking factors -- investing styles that dissect equities according to characteristics like value and momentum -- as investors size up recession risk.

Wall Street Races to Figure Out If the Quant Stock Shock Is Over

A bullish case is emerging for those betting on a lasting shift: Global economic data haven’t delivered such positive surprises in more than a year, and central bank stimulus can extend the market cycle. That should be good news for value, or cheap stocks which are deemed higher risk. An oil spike boosting battered energy shares -- part of the cohort given their volatile nature -- only strengthens the case.

“It’s overdue,” said George Mussalli, chief investment officer at PanAgora Asset. “If you look at value stocks like AT&T and GM, they haven’t gone anywhere in three years while the whole market has rallied.”

Yet timing factor performance can be a thankless task, as many value bulls will testify. Before this month, investors had been piling into the defensive shares such as utilities and soap makers that make up momentum portfolios and shunning riskier value stocks along the way.

As big as September’s rotation was, there have been similar shifts in the past year -- quickly snuffed out as investors returned to safer bets amid lingering fears over growth and the trade war. The question is whether last week’s spirited rotation has legs.

Wall Street Races to Figure Out If the Quant Stock Shock Is Over

Bank of America points to improving economic data and forecasts for re-accelerating profit growth from the end of this year -- paving the way for conditions that benefit the car makers and banks that typically populate value baskets.

Even after its recent rally, value is still incredibly cheap versus growth stocks. The former’s strongly negative correlation with momentum suggests positioning is still stretched, strategists led by strategists led by Savita Subramanian argue, meaning outperformance for cheap shares is likely to follow.

“Crowding risk in momentum relative to value remained elevated, causing additional pressure for the value spring to uncoil,” they wrote in a Monday note.

Wall Street Races to Figure Out If the Quant Stock Shock Is Over

To skeptics, last week’s move was a blip. Investors flocked earlier to defensive stocks which then became momentum, and they avoided value because they were anxious over the economic outlook. The business cycle looked extended and U.S.-China trade tensions were riding high -- conditions that have barely changed.

“Short term, the rotation favoring value should continue” to be supported by rising yields, Evercore ISI strategists led by Dennis DeBusschere wrote in a note. “However, as the outlook for global growth remains weak, the recent reversal into value is more a short-term rebound than a long-term trend.”

Strategists at Goldman Sachs are similarly unconvinced, pointing to still low bond yields and weak growth prospects.

Recent history may be on their side. The last time momentum plunged by as much in one day in 2009, it surged by nearly as much less than two weeks later, Bloomberg portfolios show. A similar reversal occurred after value’s jump in 2008.

For value adherents like PanAgora’s Mussalli, however, there are lessons further back in time. After the dot-com bubble burst, previously unloved cheap stocks saw a period of stellar outperformance.

Wall Street Races to Figure Out If the Quant Stock Shock Is Over

The bond yield curve is also starting to steepen, a trend that tends to favor value and signal a rosier economic picture. That’s another sign the shift into cyclical and more volatile shares will continue, according to Jefferies.

“Risk aversion has been rife and position unwinding suggests a lot of room for high beta and cyclicals to perform,” strategists led by Sean Darby wrote in a note.

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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