09/18/18 10:01 AM EDT


“Investors should always keep in mind that the most important metric is not the returns achieved but the returns weighed against the risks incurred. Ultimately, nothing should be more important to investors than the ability to sleep soundly at night.”

-Seth Klarman


Ben Ryan



There is obviously an element of over-simplicity in quotes like this. You can read it 10 times a day for the next year and it won’t trigger Baupost-like returns for your portfolio until you sail into the sunset. “Risk” for one, is an opaque term with a definition that sparks contentious debate between followers associated with different beliefs about how the world works (or how to model it).

One thing we try to hammer home so that our clients can understand our process is “rate-of-change” and “trends.” We spend most of our time refining our process around those two principles. Surprisingly these two terms also spark debate.

As Keith likes to say, “one day does not make a trend.”


This morning we’re going heavy on “trends”…

Amazon (AMZN) and Netflix (NFLX) have led the FAANG exposures YTD, but yesterday’s bloodbath was an ugly pullback. Those two stocks led mega-cap growth exposures to the downside at -3.9% for NFLX and -3.1% for AMZN.

Below we want to unpack key internals & factor risk in the sector. There are signs of some important trends developing. Risk-managing the FAANG in 2018 has been a different animal than 2017 and trending in the direction of “hairy”. Most things we comment on below are 2 to 6-Mth performance trends because that duration matches well with our key intermediate-term “TREND” signals and GIP-Modeling process for Global Macro Asset Allocation:

·        3 out of 5 FAANG stocks are now underperforming the Nasdaq 100 over the last 3 months and those same stocks have broken TREND (Now BEARISH) – we provide risk ranges for each at the bottom

·        Of our macro universe with well-over 100 tickers across global equity and FICC markets where we measure and map past and forward-looking volatility trends, 4 out of 5 FAANG names screen in the top 10 of that universe with the largest surge in front-month hedging costs over the last month. We observe this surge in “hedging costs” by backing out implied volatility from the price of at-the-money puts for each vehicle in that universe.

·        Beta coefficients (6mth beta vs. SPX) in the FAANG names have opened up to 1.1-1.8 making the wrong individual security picks a much larger trending portfolio risk.

·        To expand on our “beta” comment above with some time series context, we have created capitalization-weighted indices of 1, 2 and 3-Mth trending volatility in FAANG. To use an example, 2-Mth realized volatility in the FAANG names as a ratio of 2-Mth S&P 500 Index volatility has steadily expanded from 1.5 to start the year to 3.5 currentlyThat is visual #1 (left-side) in our Chart of the Day.

·        Multiple views of “dispersion” show how costly it has been in 2018 to pick the wrong securities in the Mega-Cap “growth” space. We show a rolling chart of 2-Mth performance between the best-performing and worst-performing FAANG stocks. Again, it exemplifies the cost of being overweight the wrong FAANG stock in the wrong period of time. That is visual #2 (right-side) in our Chart of the Day.

·        It’s increasingly difficult for managers to avoid these names in the “Info-Tech sector” no matter what your mandate. The sector weighting in the Russell 1000 Index has grown from 17% in 2013 to 26% currently.

·        Perhaps the most important point this morning, there is HUGE sector risk to “momentum” strategies starting to dump names in the sector. For example, the sector weighting to a popular momentum strategy (employed in the MSCI USA Index by I-Shares via the ETF “MTUM”) has grown from 6% in 2013 to 42% currently which is very cyclical.

…More on Momentum…. You can look at trending 6-Mth RELATIVE performance on two fronts:

1.    XLK over SPY: The 6-mth XLK outperformance to SPY is trending tightest since Donald Trump was elected (<1%).

2.    NYFANG Index (adds TSLA, BIDU, NVDA, BABA, TWTR to the 5 FAANG stocks – 10 total in the index) over SPY: The NYFANG Index is now underperforming the S&P 500 by 6.2% over a 6-Mth period. Remember that the most popular momentum strategies are typically concerned with 6-12 return momentum and often combine it with a volatility overlay. Strategies are built to automate for 1) Return Momentum & 2) Low-Volatility.

With everything discussed above, we’re not far off from these stocks starting to get dumped at an accelerating rate. Here are some factors supporting further rotation:

1.    Relative outperformance has slowed and perhaps many names in this sector no longer make the top decile or quintile of the universe where the strategy is run.

2.    Many of these stocks no longer exhibit “declining volatility” momentum which is a very popular overlay to security selection in automated strategies.

3.    Many strategies only rebalance quarterly, semi-annually, or annually, so there is likely more to come given recent performance sucking-wind. Whether or not the broader market can absorb that rotation is the million-dollar question.

We track various popular portfolios under 5 different style identifiers: Value, Growth, Momentum, Low-Vol & Yield, Quality

Trends of course begin with trades, and one shift that’s starting to trend is Low-Beta and Minimum Volatility strategies….

This trend of course is just another side-effect of what we discussed above, but the two top performing portfolios in our universe over the last 3 months fall-under the “Low-Vol & Yield” style umbrella:

1.    I-Shares MSCI USA Min Vol Strategy (ETF: USMV): +6.8%

2.    Invesco S&P 500 Low Volatility Strategy (ETF: SPLV): +6.5%

We will continue to favor more low-volatility, slow-growth exposures to avoid the risk associated with a dangerously high amount of net exposure in Mega-Cap “Growth” stocks.

As KM wrote in our top 3 things note this morning,

“if we’re right on Quad 4 in Q4, Tech is not where you want to be big – Q4 starts in a few weeks”

If things haven’t gotten hairy already (especially relative to 2017), Q4 could be a different animal.


Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:

UST 10yr Yield 2.86-3.02% (neutral)
SPX 2864-2910 (bullish)
NASDAQ 7848-8042 (bullish)
Shanghai Comp 2640-2721 (bearish)
Nikkei 22467-23460 (bullish)
VIX 11.75-15.57 (bullish)
USD 94.35-95.60 (bullish)
EUR/USD 1.15-1.17 (bearish)
YEN 110.50-112.41 (bearish)
Gold 1186-1212 (bearish)
Copper 2.61-2.71 (bearish)
Corn 3.45-3.65 (bearish)
FB 156-169 (bearish)
AAPL 216.23-228.70 (bullish)
AMZN 1900-2021 (bullish)
NFLX 333-375 (bearish)
GOOGL 1148-1206 (bearish)

Good Luck Out There Today,

Ben Ryan
Macro Analyst