Mo

It might be all we need to focus on right now

World Cup vibes

I have been enamored with the World Cup, as I am every four years when it is on. It only helps that it is being played in the Americas and the time of the games lines up with my schedule even better.

The celebrations, not of the players, but of the fans, is maybe the most compelling story. Whether it is the “Messias” who took over Kansas City to chair on The Goat (in a remarkable opening match), the Dutch Oranje fans performing Links Rechts (Left Right), the Norwegian fans rowing up an escalator, or the Japanese fans with the combination of endless energy but also amazing respect (cool to see other countries cleaning up after the match, hope that trend takes hold in the US!).

However, the biggest story has to be the Tartan Army from Scotland taking over the city of Boston. Whether it was the enthusiastic songs and chants during the match, taking over Fenway park during a baseball game standing and singing the whole game, or literally drinking the city of Boston dry, they have clearly left a mark.

As reporters interviewed bar owners about the historic drinking (“triple what we do on a St. Patrick’s Day”), I had to think to myself, “what would Moe from the Simpsons had done?” Maybe the most famous bartender of my generation, the dark and surly character would have to have broken a smile for the positive energy and enthusiasm for the Tartan Army, right?

Well, Moe from the Simpsons isn’t the only Mo on my mind these days. MoMo (as momentum is often called in finance) has been the single biggest factor to focus on year to date.

Market vibes

23.4% on a long-short, sector-neutral basis for 5.5 months is insane performance. It is '“take the rest of the year off” type of performance. If you funded this by going short Low Volatility as well, you are getting bid away by Citadel next year I am sure. This is the stuff of legends, but indicative that there is only one game in town. Mike Green, who has popularized the impact of passive money on the market, would tell you it is a function of passive money and indexes dominating the market, changing the microstructure.

If we look on a 5-year basis, this price momentum factor would certainly corroborate that. Again, long-short, sector-neutral and the price momentum factor is up 100% over 5 years compared with the market and all of its inherent volatility up 81% in the same period. However, is it just mindless price momentum? Price momentum, a.k.a. trend-following, is a valid strategy for many in the commodity trading advisor/futures market. The equity market is driven by other things, though, right?

Is this based on anything real?

Michael Kantrowicz, the Investors Intelligence #1 rated strategist, highlighted that EPS momentum is also working extremely well. This is based purely on the fundamental idea that earnings are improving. It isn’t just an AI-hype trade or a tech-centric idea either. EPS Momentum ex-Tech, as he shows above, is working extremely well this year and has been for the last few, driven entirely by improving next 12 month earnings forecasts. Fundamental investors always want to own securities where earnings are improving. Right now, not only are the bottom-up fundamental investors buying them, the top-down quantitative investors are also buying them. EPS momentum leads to price momentum and you get your historic performance in the long-short, sector-neutral factor.

Kantro goes on to show that EPS momentum is working in every facet of the market in the US and even in the Global ex-USA baskets. It even pre-dates the world football fans coming to the US, so it isn’t the Tartan Army calling their bookies back in Edinburgh getting in on the action. Small cap, mid cap, large cap - pick your favorite size, as long as those stocks have earnings momentum. Are you a value or growth investor? It doesn’t matter as long as the names you are looking at have EPS momentum. It is not common to see this consistency of performance in a single factor across the entire global market, but we are. In fact, in my Investment Management Academy at University of Illinois, it has become the single most important screening factor at the start of the process. This doesn’t mean we buy solely when we find it, but the names in that screen are the ones where we dig in for the deep dive on the sustainability of the EPS momentum.

It can’t be that easy

Whether they are in my Investment Management Academy or in my Applied Portfolio Management class, students have grown to know this is one of my favorite charts. It is on a test every single semester in some way, and I bring it up in discussion multiple times. This chart of the earnings expectation life cycle comes from Savita Subramanian at BAML and I have shared it on Stay Vigilant before. Every investor has lived this entire life cycle multiple times in their investing careers. Right now, we are in that 10-11 o’clock phase of estimate revisions and positive EPS momentum. We know the risk is that this growth gets “torpedoed” at some point.

I was a guest on the Options Insider Pro Q&A yesterday and a listener asked me the question of my market outlook and what would get me to change my opinion. (This is a great podcast channel to listen to as they have a ton of different and informative content) My answer was: I am positive on the market because the economy is better than expected which has led to earnings being better than expected. I will change my mind when earnings start to disappoint, because it will be earnings and not multiples that drive the tape. Q2 earnings will start in mid-July and run through August. In the interim period, and with the both the World Cup and the 250th US birthday celebrations happening before then, I would not expect much change to that factor performance or the market. However, as we start to position portfolios ahead of earnings, we need to ask the question about the sustainability of EPS momentum.

The economy leads earnings and earnings lead stocks. The ISM report this past month was much better than expected. I have shown before how it is catching up with the regional Fed surveys and the new orders to inventory ratio from within the ISM. This is important because the ISM leads earnings revisions. We can see in the chart above the ISM leading the SPX positive surprise measure by 3-6 months or 1-2 quarters. As we start to position for Q2 earnings, the question becomes “can the market beat the high expectations?” Based on the latest economic data, which we will certainly keep watching, the answer would be “yes”. Positive eps surprises mean positive eps revisions mean positive eps momentum. Mo

It is not without some risk though. I showed this chart and discussed it on LinkedIn today:

Chart of the Day - volatility

Anyone living in Illinois, or the Midwest overall, will tell you that this year the weather seems more volatile than it has in quite some time

We have had the big temperature swings that we have seen before, we have just seen them more frequently. Any amateur meteorologist, or someone growing up here, knows that when the warm fronts and cold fronts collide, we get the possibility of a tornado

Illinois has had the most tornadoes in the US so far this year - 140. The next closest is Mississippi at 82. The average number of tornadoes Illinois gets in a year is 54, so it is safe to say that the weather is more volatile this year

Volatility was also the topic of discussion on my The Options Insider Pro Q&A yesterday. Y'all should check out the podcasts at The Options Insider as they really keep you in the loop as to what is going on in the options market

As usual, the questions were outstanding and a testament to the sophistication of the audience for this pod. A lot of the talk was on the very large swings in the market and single stock/theme volatility

For those only watching the options market casually, you might be wondering - what volatility? If you look at the VIX Index as a measure of volatility, you would see it is pretty average at 16. Yes, there was a spike in late Feb/early March at the start of the war but it has been average otherwise

However, if you look at the volatility of the average constituent of the index in white, you can see it has been trending higher for the last several years and is in the top quintile of readings for the past 5 years

This leads to an implied correlation in the market in the single digits which is in the bottom decile of readings over the last 20 years

Said another way, single names and etf's are moving a lot but the overall index is just average

This suggests right now is a 'market of stocks' and not a 'stock market'. As much as the 'macro' dominates the headlines, the price movement is very 'micro'. It is a stock pickers market

Using the tornado analogy, it means that Illinois and Mississippi are having volatile weather years, but for the US overall, it is just average - which happens to be the case

Pick your reason for this - passive money influence on the market microstructure, K-shaped market, AI as the only theme, factor investing dominating led by momentum etc. The reality some parts of the market are volatile on the upside, some on the downside, but overall, the market is pretty average

I asked Yahoo Scout on Alphaspace by Yahoo Finance what the forward returns are for the SPX when implied correlation is in the single digits (it agrees it is an extreme reading on downside) and it said:

1-month: +0.5-1.5%
3-month: -1% - +2%
6-month: -3% - +3%

This compares to the average"
1-month: +0.7%
3-month: +2.1%
6-month: +4.2%

This does not predict anything bad, certainly not imminently. It does suggest you need to be careful out there

In summary

Right now, even Moe Szyslak from The Simpsons has to be smiling. Maybe it is because the World Cup fans in Springfield are drinking him dry. Maybe it is because his 401k or IRA is invested in the price momentum or earnings momentum factors. In fact, it doesn’t matter whether he is invested in US or Global, Value or Growth, Large, Mid or Small caps, he is likely invested in momentum because it is the only game in town.

That doesn’t mean there aren’t risks. The risks probably percolate as we go into Q2 earnings season and likely as we begin to focus on the mid-term elections. For now, with the World Cup on, 4th of July celebrations to be planned, and markets trending higher, maybe it is time to sit back and enjoy. Maybe even crack a smile. Even if you are Moe.

Stay Vigilant