A Crowd Is Your Enemy as Too Many Funds Worsen Earnings-Day Pain

  • Popular shares fall more when earnings dissapoint: Bernstein
  • Least crowded shares post 2.2 percent gain after earnings miss

One way of limiting losses this earnings season is to figure out what everyone else is buying and do the opposite.

More than in past quarters, owning popular stocks this month has resulted in disproportionate pain when company earnings failed to live up to forecasts, according to Sanford C. Bernstein & Co.’s quantitative analyst group headed by Ann Larson. At the same time, hiding in the least-loved parts of the market has been a workable strategy for protection.

The Bernstein analysis measured crowding based on institutional ownership, sentiment and expectation metrics like earnings forecasts and valuation. By that measure, popular stocks gained 0.6 percent on average after beating or matching earnings estimates, compared with 4.8 percent for the least crowded. When a company missed, crowded shares lost 5.9 percent. Unloved shares actually managed to rise 2.2 percent.

“Pessimism here reduces the effect of negative news, while allowing for additional upside from positive news,” Larson wrote in a note to clients Tuesday. “Crowded trades are typically already priced for perfection, and as such incremental positive news has little impact, whereas negative news has a more pronounced effect.”

It’s been a rough 2016 for the consensus. In addition to the pummeling of favorites on earnings day, momentum strategies seized up at hedge funds, traders made ill-advised bets on volatility and stock-pickers clung to wagers that caused them to trail benchmark indexes at an unprecedented rate.

While popular megacap technology companies propped up the S&P 500 last year, they’ve been punished at the slightest indication of earnings weakness. Google parent Alphabet Inc., which was the second biggest contributor to S&P 500 gains in 2015, reported revenue that fell under analyst’s forecasts on Thursday. The next day the shares tumbled 5.4 percent, the worst reaction since January 2012, when the company posted its first earnings miss under Larry Page.

Then there’s companies like Under Armour Inc., the third most shorted stock in the benchmark according to Markit Ltd. data compiled by Bloomberg. After reporting earnings on Thursday, it surged 6.8 percent, the biggest gain since it reported fourth quarter results Jan. 28.

“There are investors out there following trends, and that works out until it doesn’t,” said Ernie Cecilia, chief investment officer at Bryn Mawr Trust Co., which oversees $8.5 billion in Bryn Mawr, Pennsylvania. “Expectation for the ability of the company to perform in terms of reporting revenue and earnings are already fairly high, and because of the fact that this trade is crowded, their propensity to continue to excel is less.”

When broken down by industries, consumer staples registers as the most crowded among the S&P 500’s 10 groups, according to Larson. Since Alcoa Inc. kicked off earnings season on April 11, staples stocks have fallen 1.8 percent, the biggest decline after utilities. Yet from March to April, investors rotated into consumer staples more than any other trade, according to a survey conducted by Bank of America Corp.

Drilling down, the household and personal products industry is the most crowded of the crowded. They’ve performed the worst out of all 24 S&P 500 industry groups, falling 4.1 percent since April 11.

Investors have piled into consumer staples because they offer substantial yields in a slow growth environment, Cecilia said. That’s resulted in dividend payers with the highest valuations on record. If the Fed doesn’t move and rates stay low, that may cause investors to pile back in when prices dip, he said.

“Returns in the market are going to be subdued over the next several years, and a larger portion of that return will be generated via dividend growth,” Cecilia said. “Even though a lot of these income and higher yielding stocks may be crowded trades, they might continue to be crowded trades.”

About 30 percent of S&P 500 companies have reported first-quarter earnings so far, and there are still plenty of crowded stocks left to go, according to Larson. Among them, the most popular with high expectations include Amazon.com Inc., Facebook Inc., and Centene Corp., all of which are anticipated to grow earnings more than 40 percent year-over-year.

“We are expecting limited gains from these stocks as there is little headroom left for a significant upside surprise,” wrote Larson. For less loved companies like United Parcel Service Inc. and Aflac Inc., “pessimism here should reduce the penalty associated with a negative revision or surprise, while allowing for substantial upside potential if positive news is reported.”

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