We noted previously [7] that last week's face-ripping rally was the biggest short-squeeze sicne 2011, but, as SocGen notes, this "savage reversal" - as the biggest losers rebounded - was the worst price momentum whiplash since 2009. Bear market rallies are typically characterised by sharp reversals and elevated levels of volatility, and as SocGen warns there are several things which point to this being a technical bounce (rather than longer-term supportive value-seeking).
The last 8 days have seen a massive short-squeeze...
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And, as SocGen's Andrew Lapthorne details, this was the worst price momentum whiplash since 2009...
Such a savage reversal in such a short space of time will undoubtedly lead to significant head scratching. But surely the newly found attraction in all things super-cyclical and beaten-up is not simply down to the Fed (and others) backing away from a tiny interest rate rise? Especially when you consider continuing evidence that we are in a slowdown phase.
The chart below quantifies recent price momentum losses. It shows a long/short global price momentum strategy which lost almost 10% in six days, the worst such drawdown since the painful 2009.
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It is reminiscent of the sharp oil-related reversal of early 1998. We have also seen a surge in the performance of Value strategies (our SGVB rose 6.7% last week, the strongest weekly gain since 2011). However long/short value gains on distressed valuation metrics like price to book have been only 4.8%. The rebound looks more technical than value seeking.
Bear market rallies are typically characterised by sharp reversals and elevated levels of volatility, and there are several things which point to this being a technical bounce.
For example those stocks leading the charge were the stocks most beaten up over the prior year. The 5% of stocks most down from their 12-month peak rallied 23% in just 6 days. We also know that it is unwise to be short going into a US reporting season, as the pre-positioning of EPS forecasts leaves the market open to artificially created positive surprises, especially if you enter the reporting season with the market down and EPS momentum on its knees.
Notably, Goldman Sachs' David Kostin confirms the technical rip, noting that the 10% plunge in our long/short 12-month momentum factor ranks in the 1st percentile of weekly returns since 1980...
Two questions dominated client conversations this week. First, how should a portfolio manager view the recent momentum reversal in US stock performance? Second, will the market rally persist through yearend?
Our answers: (1) The 10% momentum reversal (as measured by the best vs. worst performing S&P 500 stocks) during the past week offset less than one third of the May to September momentum rally. Further, a momentum reversal rally by definition is powered by sectors and stocks that have been severe laggards, but the rally in lagging cyclicals is not supported by either an improved profit outlook nor by extreme undervaluation. (2) Major market risks between now and year-end support our forecast that the S&P 500 will close at 2000, roughly unchanged from the present level.
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We re-visited the momentum question this week given the relative underperformance of the best vs. worst S&P 500 stocks. The momentum reversal was certainly intense: the past week’s 10% decline in our long/short factor (ranks in the 1st percentile of weekly momentum returns since 1980. However, this drawdown pales in comparison to the trend during the past five months. Even including the recent reversal, since the start of May the long/short momentum trade has returned 22%.
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The last 2 times stocks were short-squeezed this much, did not end well...
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Charts: Bloomberg and Societe Generale
