Having Conquered FAAMG, Goldman Takes On BAT (Baidu, Alibaba, Tencent)

Last Thursday, Goldman’s prop desk decided they needed a lower entry point for the tech stocks that have together accounted for nearly 50% of the market’s YTD gains, so they stood up from their chairs, leaned over the desk dividers, and asked the research team if they’d help.

Fast forward to Friday and Goldman released some “tactical considerations” about FANG. The title of the note was really ambiguous (sarcasm alert):


Basically, Goldman suggested that FAAMG has turned into its own vol. control fund and that any spike in volatility could very well lead to a nightmarish deleveraging event. Here’s the money quote:

If FAAMG was its own sector, it would screen as having the lowest realized volatility in the market. How can low vol create a problem? Investors are increasingly focused on “volatility-adjusted” returns as they are deciding which stocks to invest in. We believe low realized volatility can potentially lead people to underestimate the risks inherent in these businesses including cyclical exposure, potential regulations regarding online activity or antitrust concerns or disruption risk as they encroach into each other’s businesses.

Mechanically, we expect that as the realized volatility of a stock drops, more passive “low vol” strategies buy the stock, pushing up the return and dampening downside volatility. The fear is that if fundamental events cause volatility to rise, these same passive vehicles will sell and exacerbate downside volatility.

In case you weren’t picking up what they were laying down, they added this to eliminate the ambiguity:

Also worth watching: the current P/E of our long/short Momentum factor is 1.8 std. deviations above its 3-year average — a level last seen in early 2016 prior to “Factormageddon.”

That of course contributed to a brutal tech selloff which eventually went global and after the smoke had cleared on Monday evening, Goldman became that dog that tears up your entire fucking living room and then looks around like “who did this?” when you walk in the door from work, claiming “it’s difficult to isolate the reason for the sell-off…


On Thursday, Goldman is out with some more “tactical considerations” in a follow-up note called “Tactical Considerations: If ‘FANG’ is mispriced, what about ‘BAT’?”

Yes, “what about ‘BAT'”?

Goldman’s conclusion:

While we recognize that many similarities exist (i.e. the fall in volatility, key index performance contributors), we also find some key differences in ownership structure, positioning, momentum valuation, which suggest that BAT’s unintended consequences of performance do not look as extreme.

And here are the details…

Via Goldman

  • Ownership – While BAT carries an aggregate weight of ~10%/31% in the MSCI AEJ/MSCI China indices, and BAT is responsible for ~15%/37% of the MSCI AEJ/MSCI China performances YTD (Exhibit 2), the passive ownership is at a lower level than for FAAMG (Facebook, Amazon, Apple, Microsoft and Alphabet). Additionally, while global funds are overweight China Internet, EM and AEJ funds remain underweight – this compares with FAAMG being in the top 10 of the US Portfolio Strategy Hedge Fund VIP basket.
  • Through The Factor Lens – One of the strongest relationships of BAT with our Investment Profile (IP) factors is, unsurprisingly, with Momentum, for which correlation is at the 71th percentile vs. its 18-month history (Exhibit 5). Having said that, the valuation is not high at the current P/E of the AEJ long/short Momentum factor has expanded YTD but is only approaching its 3-year historical average, well below some previous peaks at +2 standard deviations (Exhibit 3). This is in contrast with FAAMG whose performance has created a valuation air pocket with the US Momentum factor’s P/E standing at 1.8 standard deviations above its 3-year average — a level last seen in early 2016 prior to “Factormageddon.” Also, AEJ Tech does not appear as in the top sectors with factor correlations, vs. US Tech showing elevated correlation with both Momentum and Growth (both in the 90th+ percentile vs. 5 years) (Exhibit 4).
  • To the question ‘is BAT the new “Staples”?’, there is no straight answer and it depends on one’s appreciation of their cyclicality and the risks associated to their business models and achieving their forward growth path. (1) BAT Index realized volatility is higher compared to other MSCI AEJ sectors (Exhibit 9), as one would expect. (2) BAT has seen its realized volatility falling since Feb 2016 (Exhibit 8), notably a function of the overall low volatility market environment we are in. (3) The options market is pricing BAT volatility to increase. BAT average 3m implied volatility of 27.3% is 5.4% points above recent realized and has been rising after hitting a low in April (Exhibit 8); and (4) Correlation of BAT with US 10-yr treasury yields has turned negative since early March (Exhibit 8) — similarly to FAAMG — implying that higher bond yields will weigh on stocks, which can be at odds with the perception that those stocks are cyclical. Moreover, looking at “volatility-adjusted returns, the higher volatility of BAT stocks (vs. FAAMG) shows that the inherent downside risk from potential government regulations regarding online activity or disruption risk from new technology/ businesses/market share changes is being more priced by investors in those names than in FAAMG.


A Word on Performance and SEC/TSMC – Alibaba and Tencent are by and large the main outperformers and have added US$236bn of market cap, the equivalent of the market cap of China Mobile. While Baidu is a laggard performance wise and a smaller market cap/index weight vs. BA and therefore does not contribute to the acronym’s performance, the question then is whether Samsung Electronics (005930.KS, NC) and Taiwan Semiconductor Manufacturing Co. (TSMC) (2330.TW, Neutral, NT$207) should be in the acronym. In this report, we have decided not to include them as both have large weights in their respective country indices (20% and 18% respectively) and therefore carry a large country factor. Additionally, their contribution to the MSCI AEJ performance is much lower than BA. On the realized volatility front, while Samsung Electronics’ is 16.9, much lower than BAT at 21.8, TSMC is higher at 23.1.


In the US, driven by the rise of mega-tech, Momentum, as a factor, has built a valuation air pocket underneath it creating cause for a pause. In AEJ, while momentum has rallied YTD (+3% YTD 2017 vs. -10% in 2016), valuations don’t look stretched at close to the 3 year average.


What has driven the re-rating of Momentum? Mainly Integrated (a proxy for Quality) and Growth on a Factor basis.


BAT through a Factor Lens – Correlation between Momentum and BAT is currently higher vs. before the US Presidential Election and is now at the 71st percentile vs. the last 18 months — for comparison, FAAMG is at a 96th percentile vs. its 5-year history. The most interesting observation there is that correlation between BAT and the Value Factor (cheap vs. expensive) briefly turned positive and currently stands at -6%, a 93rd percentile (vs. -35% for FAAMG, a 2nd percentile vs. 5 years).  This is consistent with the return decomposition analysis done by our Quantitative Research analyst, Tsumugi Akiba, which shows that since March 2016, value has been a major factor driving the share price, at the expense of ‘Momentum’.

Are BAT the new “Staples”? – While our US team makes the point that if FAAMG was its own sector, it would screen as having the lowest realized volatility in the market, volatility for BAT has both positive and worrying aspects. On the positive side, realized volume for BAT is high vs. sectors. And while BAT’s volatility has been coming down and the gap has narrowed with Staples, it has also narrowed with Tech and the overall index. Part of it can be explained by the low volatility in the market overall; part of it could be due to a better appreciation/clearer understanding of the equity story on Alibaba and Tencent and their potential path forward.



Having said that, the options market is not pricing BAT volatility to remain this low. And similar to FAAMG in this instance, since early March, the correlation between BAT and the 10-year US treasury yields has turn negative.



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