At the end of last year, the influence of the market (read: macro) on stock returns was at an-all time high, with stock-specific, idiosyncratic factors taking a backseat – it was a clear signal to abandon macro over stock-picking. Through 2010, stock-picking has been in fashion. The evidence of how little influence macro has had on the behavior of stocks is in the correlation of returns from individual stocks (market effect) with the market, which has collapsed over the past 12 months. Conversely, the average relative volatility of the stocks in our coverage universe had rocketed to a five- year high. The fall in market effect tells us that individual stocks were being influenced more by idiosyncratic, or non-market, performance-related issues than by market performance-related factors. However, it is unlikely that macro effect falls further, or for too long, and, to that extent, stock pickers may have to take a back seat in the coming months.
Investors who are wary of the market may seek to buy protection by going down the beta curve. However, they need to bear two points in mind: 1) beta is constantly evolving – for example since Feb-09, the telecoms beta has gone up, whereas for materials it has declined – we expect more beta from staples and less beta from telecoms in 2011; and b) The components of beta (relative volatility and correlation of returns between the stock and the index – i.e., market effect) are as critical in a “beta strategy” as the beta itself. Our conclusion is that stock picking may become less important in the coming months relative to where it has been in 2010, and that investors could start focusing on sector trades and large caps.
