Searching Google for “Retail Apocalypse” returns 8.8 million results (in .45 seconds!). For the better part of a decade the sector has been beaten up in the press. The headlines are not unfounded. Former staples of American consumerism such as Toys-R-Us, Radio Shack, and Payless ShoeSource are no longer, while many others struggle to find stable ground. The negative hype surrounding the Retail Apocalypse has created a fog around the whole sector and retail stocks have not been a popular pick amongst active money managers in recent memory.
Behind the retail apocalypse headlines are companies who have adapted to new market conditions, have strong balance sheets, and forward-thinking management. Looking into the fog, we see a shunned sector, overly beaten down valuations, and good potential to seek out value. Our Mount Lucas Focused Large Cap Value currently holds 4 retail names amongst its 36 total holdings. Some may view this as a high concentration of an unpopular sector for a focused strategy which holds no more than 40 stocks. However, our quantitative stock picking algorithms have no such opinions, they are programmed to seek value.
Below are the 4 retail names currently being held in the strategy, each picked for the portfolio on Sept. 22, 2017. Presented are price charts with selection date indicated and resulting price move, as well as headlines from the time preceding selection. Even positive news is tinged with negatively worded headlines. We believe this illustrates the headline fear and peer pressures that all human stock pickers face, as well as the benefit of a non-biased quantitative approach to value investing.
Mount Lucas Focused Large Cap Value Strategy Information
In light of recent market performance, and the corresponding effect on changes in volatility on CTA returns we thought it important to give our views on the topic. Late last year, we were asked by a prospective client to see how one of our trend following models performed over several different stress environments. We highlight one particular stress that was given- a 20% stock market drop over 3 months, with 40% of move in month 1, 35% in month 2, and the last 25% of the move in month 3. A relatively straightforward exercise, but to really understand the nuances of different CTAs relative to our approach, you must look past just the change in level, but consider the potential price paths and volatility over that stress period. The difference boils down to whether one is viewing CTAs as a standalone investment, or as a piece of a larger portfolio, and the role of volatility targeting in position sizing.
There is a saying in our business,”the trend is your friend.” Given the recent downturn in trend following returns, I am reminded of another saying, “with friends like these, who needs enemies.” I was in a meeting recently with a consultant who asked a question we have heard many times over the years. How do you keep clients invested in managed futures in times like these? We know the history, the diversification benefits, the crisis protection, the long volatility profile…but, each time there is an extended period of challenging performance clients look to throw in the towel – because their equity investments are ripping up and managed futures is down. A good question, and the answer, I think, lies in the statement – it is a matter of faith.
Investors in the equity market have faith. They trust, and have been conditioned, that the market goes up over time, corrections are temporary. Participating in the capital formation of companies provides a risk premium to the investor and is an investment in the economic growth of a country.
Managed futures on the other hand is viewed as a trading strategy, it goes long and short, it is typically quantitative based. The perception is…I can’t have faith in a model, it can break. But this perception is misplaced, trend following measures a real economic risk premium in the market, just like equities (see older posts diving deeper on this topic, Portfolio Symmetry, Commodities are not Stocks, Benchmarking Alternative Beta). Investors in this market are rewarded by taking the price risk companies seek to shed. Faith should be in the durability of this premium, just like there is in the equity risk premium. Faith is gained by understanding this risk premium, when it works (periods of volatility and instability), and when it doesn’t (periods of low volatility and stability). Similar to equities, faith should be garnered from the underlying economics of the markets.
Whatever your politics, one can’t help but be fascinated by the Trump phenomenon. One interesting aspect is how pollsters got Trump wrong. We can get insight into that mistake from Nate Silver at fivethirtyeight. To his immense credit, Silver admits he got Trump all wrong, and went back to have a look at the why and the how…. it boils down to a case of algorithmic aversion (see here and here).
Silver’s approach to forecasting, which has been extremely successful across a wide range of subjects, is based on aggregating data from multiple polls to build as big a sample as possible. It is a mechanical, quantitative, model based, statistical method. The model spits out an answer, and that is forecast. But in the Trump case, he over-rode the model. He had a bias, and in this instance he applied it to his forecast, and voila, a bad outcome. Even Silver, a devoted algorithmist if there ever was one, fell into the trap. He did not trust the model, even though it had been right so many times before.