Blue Chip momentum carnage

Anyone who follows goings-on in the 'quant' world (as this column's author nerdishly does) will already have got the message about momentum: it’s been whacked, and whacked bad. What is heralded by some as a 'great rotation' from 'growth' to 'value' has upended momentum strategies. 

That’s no surprise because this approach to investing pegs its colours to whatever trend has been dominant in the recent past. So it comes off badly when dominant trends sharply reverse. My classic blue-chip momentum screen provides a front-row seat to the recent carnage.

It is the screen's negative 'short' picks that provide the real spectacle here. Those shares that were most downtrodden when the screen was run three months ago have rallied spectacularly. These 10 market laggards have surged 37 per cent in aggregate since September. Especially for blue chips, that kind of three-month performance is truly spectacular – and spectacularly bad for anyone employing a long/short momentum strategy. As any attentive followers of this column may already know, this screen’s short picks have a habit of being very mischievous. The underperformance of the 'long' picks over the last three months was less pronounced but still marked. 

PERFORMANCE TABLES

Source: FactSet

The important thing to understand is that what we’ve recently witnessed is not so much a flaw in the momentum approach but a feature. The market’s dominant trends can change at whipsaw speed and this will always hammer returns from momentum strategies when it happens. However, momentum then responds by dusting itself off and getting on whatever horse is now out in front. 

Indeed, despite the terrible three months just endured, over a 12-month period the returns from my blue-chip momentum screen actually look pretty good and orderly. The 'longs' have outperformed the FTSE 100 index and the shorts have underperformed. The terrible quarter just experienced can be regarded as payback for the wonderful preceding six months. Meanwhile, over longer time frames the strategy continues to  look good. It should be noted, this is the one screen I run that does not attempt to factor in dealing costs or dividends in performance numbers as it is principally concerned with watching the amazing phenomenon of momentum unfold in real time. It is also designed to be of use as a source for ideas for further research and understanding market trends.

Source: Thomson Datastream/S&P CapitalIQ/FactSet

The danger for momentum strategies now is that, while the market’s switch of tack has been violent, it could also prove fleeting. The extremity of the turnaround suggests the potential for volatility even if the trend broadly persists. Indeed, while lockdown-clobbered companies have seen their shares soar on improved hopes for life returning to normal, much value has been destroyed in the interim through money raised with both equity and debt. Meanwhile, even though the economic recovery could be sharp, prospects are not what they once were for some of the companies that have recently witnessed share-price bounce backs. And lockdown may have sped up changes to behaviour, such as working from home and online shopping, which are unlikely to reverse in full, and possibly not much at all.

Due to end-of-year publishing schedules this screen is being produced ahead of the official three-monthly monitoring period which runs to the 15 December. The performance data and long and short portfolios used to track the strategy going forward will be based on the official dates, so some of the stock selections may be different. That’s especially likely given the extent of recent share price movements. 

The 10 shares making up the long and short portfolios can be found in the table below. I’ve also taken a brief look at the top five longs.

LONGS

SHORTS

*15 Sep - 25 Nov

source: FactSet

Rolls-Royce

Aerospace engines company Roll-Royce’s (RR.) share price ascent over the last three months needs to be seen in the context of falls during lockdown. At the start of October the shares were down 84 per cent from the level they began the year at. The  eye-popping bounce back since then still leaves the price at less than half the level it was at the start of the year. 

As well as the hope that the world will be returning to a semblance of normality sooner than expected, investors have taken heart from the fact the company looks to have averted a financing crunch. Rolls has put £5bn of new financing in place including £2bn from a deeply discounted rights issue and the same again from new bonds, which yield a worryingly high 5.75 per cent. 

While the prospect of planes getting back into the sky should help encourage some new orders and more importantly a pick-up in engine servicing work, the company is also aiming to strengthen its stretched balance sheet with asset sales. Disposal news could help support the shares’ recent rise. That said, this is still a company with some major problems to sort out. 

Two Banks

One of the most economically-sensitive parts of the UK market is the banking sector. Covid-19 and anticipation of a big recession caused blue-chip banks to book big impairments to cover expected losses on loans. Given this backdrop, the ability to once again dream of a V-shaped recovery helped by a vaccine roll-out has been a big plus for bank shares. These companies also benefit from the fact that they have much stronger balance sheets now than they did at the time of the last crisis, in which they played a front-and-centre part.

Investors are starting to think about the prospect of banks paying dividends again after they were banned by the regulator as a lockdown precaution. The chances of this happening sooner have been boosted by encouraging quarterly results from the sector including both Lloyds Banking (LLOY) and Natwest (NWG) – the two banks in the momentum top five. Both came out with numbers towards the top end of expectations and also reported strong capital positions.

Brexit remains a source of major uncertainty for the UK economy and the finance industry. A positive outcome to negotiations over a trade deal could be a major plus. However, economic pain could be drawn out and low interest rates look set to continue to drag on bank margins for some time to come. 

Taylor Wimpey

When lockdowns hit and tools were downed on building sites, the expectation was that house prices would soon tumble. The reality has been a lot better than feared, with transactions picking up briskly after lockdown finished and prices rising rather than falling.

As share prices rose in the house building sector, Taylor Wimpey (TW.) lagged its peers. However, its shares were set alight by the rotation to value and an upbeat trading statement in late November when the company said it would hit the top of the range of expectations. The company has also been spending money it raised in the summer on new land. Cash is expected to build as sales come through. Meanwhile, helped by cost controls, margins are expected to recover after dropping during lockdown.

Early next year, the company does face the withdrawal of the stamp duty cut and parts of the Help to Buy scheme. Any positive news on government action to maintain support for the housing market could help underpin momentum. Given the importance of the housing market to the broader economy and the willingness shown by the government to support it, this could happen.

Whitbread

Premier Inn owner Whitbread (WTB) has long had ambitious expansion plans. It wants to more than double the size of its budget hotels estate to 170,000 rooms across the UK and Germany. The company has a strong balance sheet following a £1bn rights issue in June and it also has a great reputation for operating hotels. 

Together that means, while lockdown travel restrictions have caused it significant pain, the damage done to competition may provide it with an excellent post-pandemic opportunity for profitable growth. So vaccine developments represent very good news for the company. 

Whitbread’s half-year results in October also provided encouragement. It demonstrated an ability to swiftly get hotels reopened following the lifting of restrictions. This helped it significantly boost market share in the UK from 7.3 per cent before lockdown to 10.8 per cent. The company also demonstrated its sense of purpose by ploughing money into hotel purchases in Germany to take advantage of the distressed market there. More news of capital deployment could help buoy investor enthusiasm for the recovery story.