Following JPM's calculation that only 10% of trading is fundamentally driven by flesh-and-blood investors, and increasing rumblings that traders now exist at the mercy of machines, many of which respond merely to fund flows and not fundamentals, SocGen's Andrew Lapthorne cross-asset strategist will have you know that he will have none of that nonsense, and in a note that is sure to spark strong reactions across Wall Street, writes this morning that "with all the talk of systematic and passive investment dominating markets and, conversely, the apparently low participation of fundamentally-driven investors in daily stock flows (which we also see), many are concluding (we’d say once again) that stock fundamentals no longer matter."
We disagree. There remains a clear correlation between changes in bottom-up consensus earnings expectations and relative share price movement – see charts below. So it is not that changes in fundamentals are not driving share prices, it is that predicting those changes is (‘twas ever thus) incredibly difficult.
What is Lapthorne's thesis? Qite the opposite of what is slowly becoming conventional knowledge, namely that value investing is dead (as Goldman recently suggested tongue-in-cheek), and that fundamentals no longer matter. Here's why:
Many also argue that quantitative systems ignore these fundamentals. However the inverse is perhaps more accurate. Any systematic strategy formulated around any notion of price momentum (we’d put volatility weighted and risk parity into this group as well) are simply following slavishly these changes in fundamentals using price as the principal signal for a change in expectations. So it is not that systematic strategies are not driven by fundamentals, it is they offer no view to the future. Forecasting fundamentals is and has always been the main problem.
If Lapthorne is right, it may be even worse news for the fundamental investing community, as it will mean that investors will have an even more difficult time generating alpha as all the same signals and factors they use to "forecast" the future as being used and abused by the entire quant industry. It also means that if indeed fundamental investors are no longer able to trade off conventional value investing signals, then the market is indeed wrong.
Only don't blame the systematic, quant community for it. Blame the Fed: recall this is what Goldman said two months ago:
- The current run of active manager underperformance began shortly after the onset of QE (see top-left exhibit).
- QE drove real interest rates lower (measured by the yield on 10yr TIPS). This trend towards 0%, and even negative, real rates coincided with the shift from active outperformance to underperformance.
- Equity market dispersion and volatility, both key drivers of manager tracking error and excess returns, have remained stubbornly low throughout QE and served as headwinds for manager performance (see bottom-right exhibit).
The bottom line: fundamentals may matter, however in a centrally-planned market, the fundamentals themselves have become noise and lost all of their signal value to both humans and algos.