Jean-Baptiste Berthon

Jean-Baptiste Berthon

Senior Strategist, Cross Asset Research

Lyxor Asset Management

Why we would start reweighting US stock-pickers

05 Nov 2018

Investment Partners

We are past the peak of earning reports in the U.S. The unusually high individual stock volatility after announcements is a pattern that only appeared, in the past, at macro inflections points. The Q3 season tells us that extra-growth from the tax reform is now behind and that Corporate America is back to cruise level. The share of beats, the size of surprises, guidance and next year's expectations all reverted to their long-term average.

After a rough start, when any stock miss were trashed, prices became increasingly consistent with the pulse in stock's fundamentals. That is a key pattern for managers who need prices to reflect the fundamentals they pick stocks for.

Meanwhile, increased dispersion at a stock and sector levels amid still moderate correlations will also provide a diversity of arbitrage opportunities. They will emerge after the dust settled, when stock trends reshape. More reasonable earning expectations will also lower the hurdle. Interestingly, US equities also showed a wider sector leadership, with the contribution from cyclicals matching for once that of tech stocks.

These improvements are not coincidental in our view. They come at a time when the US economy is probably peaking, curtailing market directionality. The Fed hiking cycle is starting to bite, with more discounted cash flows and leverage differentiation. The fading impact of tax policies will also allow, to some extent, sector and factor rotation to respond to traditional drivers (growth, rates, risk on/off etc.) rather than transversal movers.

More arbitrage opportunities from low correlation, more fundamental differentiation and increased prices rationality, a reset in most equity trends are all key ingredients which tend to stock-pickers.

It's not to say goldilocks alpha is back. For now, a majority of L/S Equity managers shrunk their overall and cyclical exposure. They would only partially benefit from a lasting rally, if any. Moreover policy uncertainty is not yet out of the picture with trade tension still likely to unsettle stock-picking opportunities for a little while.
With the nuances in mind, we would prepare to reweight U.S. stock-pickers.

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