As American equity markets awaited the onset of the earnings season (Alcoa kicks off, after the bell on Monday), consider this factoid from Matthew Rothman, Barcap’s top quant research man in New York:
Recommending stocks in the current environment may well be a fool’s errand…stock selection has rarely ever been more difficult than it has over the past 2 months. Stock return dispersion is a historically low levels with macro economic factors being chiefly responsible for the direction of stocks.
To put this in perspective, current levels of cross-sectional correlation are higher than in October 1987, anytime during the Fall of 2008, either the runup or the bursting of the Internet Bubble, or after 9/11.
Quants generally have never had it so bad as over the past 2/3 years, as the chaotic dash for trash followed the dislocations of the credit crisis, only to give way to the manic macro-led lunges (bearish and bullish) of recent months.
Not ideal conditions for stock pickers of any colour.
John Kemp at Reuters argued recently that policymakers and investors alike seemed to be over-estimating the likelihood of extreme outcomes – betting either on a huge bout of liquidity-induced inflation, or a renewed descent into recession and deflation, or possibly both at different times. (H/T Kedrosky.)
He reckons people are too transfixed by tail risks and that, in reality, we’ll all just muddle through:
One set is terrified about deflation and defaults, causing a surge out of equities and into the safest U.S. Treasury bonds. The other is worried about a resurgence of price pressures, triggering a flight from cash into hard assets and gold…
But the point about tail risks is that they lie in the tails of the distribution. Even with fat-tails, tail risks are still fairly unlikely. Having spent much of the last two decades ignoring the fat tails in returns from many assets (”kurtosis”) policymakers and investors now risk over-compensating and focusing on tail risks to the exclusion of the main body of the probability distribution.
When the current bout of panic and gloom passes, it is much more likely the global economy will continue to muddle through, with moderate growth and moderate inflation, than that it will be plunged into a Third Great Depression or some sort of hyperinflationary spiral.
Rothman at BarCap is also looking for a return to something approaching normality. In fact he’s gone back to the artisanal financial craft of screening stocks for things like strong cash-flows and the like, coming up with a filtered list of 22 companies that have benefited from some eye-catching upwards earnings revisions over recent weeks.
Full details in the usual place.
Will this catch on? Could a new era of stock-picking be upon us?