My dearest stock – “Sentiment” in equity markets isn’t that much emotional but it could prove nonetheless rewarding. The term was coined to describe a combination of equity research indicators – initially selected by JP Morgan – designed to capture market dynamics with growing interest from sell-side analysts.
Sismo is the perfect visual analytics tool to immediately identify stocks exhibiting such characteristics as a strong increase in target price (over the last 6 months), a positive change in analysts’ buy recommendation (over the last 3 months) and strong current buy recommendation expressed in percentage (i.e. % of analysts covering the stocks with a buy recommendation).
Applied to the Stoxx 600 Europe constituents as at 14 July 2017, a double-quartile screening on such criteria highlights the positive “sentiment” score of certain stocks, like steel and aluminium producers (Arcelor Mittal, Outokumpu, ThyssenKrup, NorskHydro) and other mineral resources companies (Glencore, Rio Tinto). On the opposite, telecom stocks score poorly, exhibiting negative market interest dynamics.
Double-quartile visual, a reading guide
The Sismo screen above visually conveys the whole “sentiment” information on the constituents of the Stoxx Europe 600 as at 14 July 2017. It should be read as follows:
Telecoms down, minerals up
Above is the whole screen on which we have highlighted telecom stocks with white borders, mainly located in top left corner. In median terms, indicators for telecom stocks reflect:
Here below is the same screen, but now the highlighted stocks with white borders are mineral resources stocks, located primarily in the bottom right part of the chart. In median terms, mineral resources stocks reflect:
Although both sectors currently exhibit similar level of % buy recommendations (approx. 45%), telecom stocks suffer from a persisting downward trend in terms of analysts revisions whereas mineral resources stocks have benefited from significant upward revisions in recent months.
Auto stocks on the watch list
Zooming into the bottom right corner of the chart, we get a closer look at stocks in the upper median group for the first 2 indicators (note that the value shown in each tile is the first indicator, i.e. the % change in target price over the last 6 months).
If we move a step forward and filter out stocks that are below the 50% threshold of buy recommendations and then highlight (with white borders) stocks in the Auto and Auto Parts segment, we get the following picture:
This analysis emphasizes the current positive market sentiment attached to certain auto stocks (like Ferrari, Volkswagen or Peugeot).
Back-testing the sentimental strategy: the acid-test is passed
Now before we conclude, let’s check out with Sismo’s back-testing tools the historical performance of such a “market sentiment” strategy in a factor-investing approach, with regular portfolio rebalancing.
Consider a portfolio designed to include all Stoxx 600 constituents that initially, 5 years ago, would have fell in the top 30% for all of the 3 market sentiment criteria simultaneously and would have been since then monthly rebalanced on an equal weight basis (i.e. selling stocks that don’t match criteria any longer each month and buying the new matching ones so that all stocks in portfolio would have the same weight in the market capitalization of the portfolio after each monthly rebalancing).
Without discounting for brokerage fees, such portfolio would have led to 16% annual outperformance to the Stoxx 600 over the last 5 years (i.e. +247% total 5Y return vs. +78% for the Stoxx 600). Such portfolio included on average 23 stocks, with a high turnover of nearly 50% of stocks each month.
In the previous 5 years (July 2007-July 2012), the top three deciles strategy still beats the Stoxx 600 by 7% annually on average, with a 5-year total return of 9.7% vs -22% for the Stoxx 600.
The analysis should be further developed – and the results adjusted for brokerage fees – but it looks like being “sentimental” is not an attitude that should be ruled out, market-wise…