Market Update: IAS Strategies

February 4, 2018

The markets had an unfamiliar week, didn’t they? We haven’t seen a down week like this since 2016 before the elections! The markets were down around 4% this week. And of course, that has lots of clients and advisors asking our opinions.

At Alpha DNA, we observe the markets thru the lens of our Internet Advantage Strategies (IAS). Our IAS strategies aim to provide excess return thru two sources: (1) Stock selection of companies that will deliver surprise revenue and EPS performance; and, (2) Adjusting our net exposure as market signals show weakness.

Let’s examine where IAS stands on both of these two fronts and the implications for the current markets.

Stock Selection

First, our stock selection is built around finding firms that are growing revenue and EPS faster than Wall Street analysts are projecting. We call it the surprise factor. Over the intermediate and long run, if we find surprises, we would expect our portfolio to out-perform.

Current market timing happens to be right in the middle of quarterly earnings season. As a result, we can examine our portfolio in the context of earnings announcements. Thru last Friday November 2nd, only 9 of the stocks in our bullish side of our IAS portfolios have announced.

The results for those nine announcements: Only one out of nine missed on EPS expectations. Two others met EPS expectations. The other six all beat on EPS consensus. But more importantly to our modeling, all nine beat the analyst consensus expectations for Revenue! Earnings will ramp up more in the coming weeks so we will continue to track it. Remember that you can subscribe to updates on our earnings results. Just email us to get added to the distribution list.

So the early read on the portfolio: despite the market pullback, our results relative to finding surprises are strong. As long as our portfolio is finding surprises, we will continue to believe in that portfolio.

Net Exposure

The second source of excess return is our risk-adjustment to our net portfolio exposures. The net exposure in our Equity Long Short strategy adjusts with our proprietary risk signals. Those signals are updated daily and adjust with the market’s daily price moves.

The markets are still only a week away from their all time highs. In general, our signals still show market strength. But the signals did degrade this week slightly. And we will continue to monitor it closely.

If our signals continue to weaken, we will start to adjust the risk in the portfolio. Our first step would be to increase the beta of the short exposure in the portfolios. For the taxable accounts in the Equity L/S strategy, we will replace the short index exposure with short individual stocks. For the IRA accounts, we will switch to use options with more beta when compared to our portfolio.

If our signal degrades far enough, we will move our Equity L/S portfolio to a market neutral position. But this scenario would require more moves in the market than what we have seen thru last Friday’s close. In fact, if the signal reaches its most bearish point, we will adjust the net risk exposure in all IAS portfolios. This scenario would require more time and market moves.

To summarize, our portfolio will adjust for risk exposure if the market sell off continues and our signals continue to weaken. Those first risk adjustments could come as early as this week. If we make them, we will write about it in this blog. The move to completely move the portfolio to market neutral will require more time, however.

If you have any questions about this, call or email us at 443-288-6444 or wayne.ferbert@alphadnaim.com .