Context is everything; without it, information is just a meaningless collection of dots. Never were this more true for equity investors than heading into reporting season. In this note we identify ten stocks especially vulnerable to negative announcements in the current context.
The narrative since end of March runs like this: companies have been pulling their guidance, unable to provide any surety around earnings, revenues or cashflows in a pandemic riven world.
What has transpired in terms of investors behavior has been an adrenalin fueled rally, where, devoid of any fundamental anchor, investors have embraced speculation, risk, and trend following, at the expense of valuation ratios, quality, growth, or earnings revisions. This behavioural trait is global and ubiquitous amongst equity investors.
Resonant explicitly quantifies this behavior and its impact on stock prices in the Adrenalin Index. The Adrenalin Index, which has rallied significantly since the start of the year, is a combination of long and short positions on every stock in the S&P/ASX 200, weighted by their sensitivity to this prevailing narrative. It is yet another example where Resonant’s portfolio managers augment their judgement with complex and varied data constructs for each company, in what we call our “Quantamental” investment process.
The Adrenalin index is both sector neutral (GICS Level I) and dollar neutral – equal amounts of capital invested on the long and short side – so is reasonably impervious to fluctuations in the headline index. Note the Adrenalin Index is a losing trade: since 2011, $100 invested in this portfolio would now be worth a touch under $60. This is unsurprising: in equity markets, ignore fundamentals at your peril. (see Figure 1 below)
Figure 1: Adrenalin Index since 2011 (source Resonant Asset Management, based on raw data inputs from Refinitiv Datastream, S&P)
However, the tick-up in recent months however has been significant, and tells us a great deal about the aggregate mindset of the market at present. This is particularly true of the months of April and May in particular, at the peak of the lockdown (See Figure 2 below):
Figure 2: Adrenalin Index 2020 YTD (source Resonant Asset Management, based on raw data inputs from Refinitiv Datastream, S&P)
This key context heading into reporting season is a unique insight into potential additional fragility of stocks that have experienced an outsized share price benefit from the run-up in the Adrenalin Index. Like a fine priceless vase on the mantlepiece, even the slightest force in the wrong direction can destroy substantial value.
In addition, this is not to say that these are
necessarily poor investments – in many cases, we like these stocks on a long
term basis – but we estimate these names display additional downside risk to
negative announcement or event in the short term. (See Figure 3 below)
Figure 3: Top ten long positions in the Adrenalin Index, and hence greatest fragility heading into reporting season
How are we managing this additional risk ? Where we like the name on a longer term basis, we are merely trimming the position to reflect our updated short term view on the risk of the stock to limit our downside exposure should a negative event transpire over subsequent months.
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This key context heading into reporting season is a unique insight into potential additional fragility of stocks that have experienced an outsized share price benefit from the run-up in the Adrenalin Index. Avita Medical has not experienced an "outsized" share price-it is the equivalent to about 0.34 cents.
Thanks for the comment Brendan. While Avita has struggled, this framework suggests that the share price would now be far worse than it is now where it not for the market environment of the last few months. So a massive share price run up is not necessarily a pre-requisite for fragility. Nick