Despite the recent modest drop in stocks, the S&P remains just shy of all time highs, and near valuations which according to Goldman are at nosebleed levels and which market participants recently admitted are the most overvalued since 2000. Furthermore, with the market seemingly finding itself painfully rangebound in a world where until recently volatility was non-existent, traders desperate for alpha, have been scrambling for a strategy that produces a steady stream of profits.
One such trade was proposed overnight by SocGen’s Andrew Lapthorne, who notes that “the only strategy to stand out this year is short-term (1 month) price reversal, which involves selling last month’s winner and buying the losers.”
Here is his overnight note, according to which “Outperformance of reversal strategies points to a market struggling for direction”
Equities experienced a bit of a speed bump last week when the S&P 500 fell by more than 1% for the first time since September. The language accompanying this “steep sell-off” was really quite over-the-top, but given that the S&P 500 has declined by 1% or more on just seven occasions over the past year (versus an average of 25 per year historically), perhaps there was a pent-up desire to open the bear’s dictionary, particularly with commentators now having long exhausted the thesaurus for variations on the word “complacent”.
There is plenty to be bearish about. Equity valuations are tortuously high, with median valuations in the US and Europe near or at record highs, particularly once debt is included (i.e. on a EV/EBITDA basis). We estimate the US to be 25-30% over-valued if we compare today’s EV/EBITDA of 13 times to the 20-year average of 10 times (charts and data available on request). And earnings momentum, whilst improving in Japan and OK in Europe, is struggling in the US (1.5% has been cut from the S&P 500’s 2017 EPS so far this year, and 5% from the Russell 2000 2017 estimates), and what positive EPS momentum there is, is largely coming from Basic Materials (i.e. commodities). Expensive valuations coupled with no meaningful pick-up so far in US EPS momentum (quite the contrary for US smallcaps in fact) – and the market is struggling to make headway.
This directional doubt is also visible across our factor indices, with this year’s lack of performance dispersion across styles a complete contrast with last year’s volatility. Indeed the only strategy to stand out this year is short-term (1 month) price reversal, which involves selling last month’s winner and buying the losers.
Then again, judging by today’s sharp rebound from overnight lows, traders may be resorting to that other far more popular, and far simpler trade: BTFD.