Equities are from Venus, Bonds are from Mars

The world is often a unusual and oft-varied place. Take women and men, the latter of whom I am told are from Mar, and the former from Venus, which if my spouse and I are any indication, is accurate indeed. Or more to the point of this blog, take the fixed-income and equity markets. Bizarrely, in the USA over the past three months, "price" and "Value" have, it must be said, mattered ever more and more to lenders, evidenced by widening credit and swap spreads. This is perhaps it always has been or should always have been excepting the past four-year interlude of essentially negative real interest rates, coincidental to massively loose fiscal policies (globally) coupled with floods of both petrodollars and overseas surpluses
"willing" (at least via official sponsors) financing any and all US CA requirements at knock-down prices. This has, in Q2 and last month , been more or less halted with the mauling of the sub-prime market, and the emerging credit and de-leveraging cascade that seems to have been irreversibly set in motion.

But over in USA equityland, which I will term the "Venus" of markets for her (and it IS a "Her") frequent irrationality, unpredictability, and sheer volatile irascibleness, things have moved in the opposite direction. For over the past four months, price-related (i.e. value anchored) factors have not only had no relevance at all, but have attributed negative alpha in large quantities, not seen since 1990, Q3 2002, and the tail-end of the internet bubble in 1999. Undoubtedly, PWMT (poor white mortgage trash) things like NEW, AHM and the like have contributed on the tails. But I am measuring the returns in a variety of ways, both tails, AND cross-sectionally, and while the extremes DO impact the tails, the cross-sectional pictures are fascinating.

The flip-side of price/value factors are typically non-price factors such as variously-framed naive price momentum, earnings revision & earnings momentum, and earnings growth viewed WITHOUT respect to price/value-based factors. And these factor returns I will point out to you, resemble accelerating runaway trains. This is true in EVERY momentum frame, and most earnings-revision, earnings-momentum, and earnings-growth frames. On top of this, the fat-tail over the past four months (following Cassandra's whimsical ill-timed Crash Prediction) has NOT been on the torpedo side, but rather on the positive side of the daily distribution of returns, with some contributions from PE takeovers and mergers, but most often from a positive earnings surprise.

In a layman's nutshell, "the market" has been buying overt earnings growth, positive changes in earnings forecasts, and what went up historically WITHOUT RESPECT TO ABSOLUTE OR RELATIVE PRICE OR VALUATION ANCHORS. This is nothing new, for the market, in its periodic syphilitic or hormonal fits does de-couple from what prudence and the amthematics of discounting would otherwise suggest.
But I will point out that the gods (and probability theory) does not favor those betting with the apparent crowd at these junctures.

But as one who heeds and respects the wisdom of the crowd (though rarely follows it in positions) one must always ask whether probability (the rear-view mirror) is potentially yielding erroneous results, and the future will [continue] to depart from the past in meaningful fashion. SO what's going on? In equityland, "Value" is viewed as the anti-christ. "Growth" is the saviour himself. Like the Saviour, who is viewed differently by different cultures, so to is "growth. Some see HIM in earnings revision. Some see him in quality (EVA, CFROI, Asset turns etc.) Others in high earnings growth, and still others (the Evangelical sect IMHO) in price momentum. "Value" is unreliable as a saviour for such company earnings are too highly correlated to the market's earnings, hence have little appeal to alpha-seeking investors desiring to stand-out. This, in turn, creates a feedback loop reinforcing behavours and data-miners alike . So during times of heightened risk, the "flight to quality" disregards price, opening large anomalies for those better skilled in the art of discounting, willing to warehouse quality risk and stomach the P&L variability. Needless to say, during times of a macroeconomic dislocation that sees deleveraging as the norm, taking on additional quantities of such "risk", ends up pretty low on the totem pole, when firms are coming to terms with redemptions, margin calls, untold quantities of dubious mortgage & junky PE debt on their books, in addition the opportunities that such fixed-income spread widening yields to all.

There IS opportunity in this equity spread for cowards. But given that the positive momentum tail is so absolutely expensive, and the "cheap tail" not all that absolutely cheap, either to the market or itself, for the brave, the trade is probably to drill the most expensive stocks, particularly ones with some US PCE component or sensitivity, for many of these players are also leveraged, and systematic, and amidst a crappy market, a fishing expedition for stops and pain thresholds in ostensibly very overvalued situations might shake more fruit from the tree than otherwise might be the case.