Heads up FAANG, or FAAMG, or whatever the hell the acronym is these days.
Goldman is back on Tuesday with an update to the thesis that underpinned the now infamous FAANG note that triggered a mini-rout in tech on June 9.
You’ll recall that the most important takeaway from the bank’s analysis was that tech stocks have become synonymous not only with growth and momentum (that’s kind of tautological), but also with low-vol.
Here’s the important 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 other words, these tech stocks are starting to get treated like something they are not by virtue of the self-feeding loop that creates the illusion of low volatility in names that are inherently subject to considerable risk.
Hot on the heels of that Goldman report was Bloomberg’s Dani Burger to warn that increasingly, low vol. ETFs are upping their tech exposure to record levels. That is of course part of the above-mentioned self-feeding dynamic that Howard Marks recently warned can be pernicious.
Of course the hilarious thing about that Goldman note was that it was a self-fulfilling prophecy. That is, it catalyzed a tech sell-off which certainly had a mechanical feel to it (see here from SocGen’s Andrew Lapthorne) and sure enough, the Nasdaq VIX spiked to its most extreme relative to the S&P VIX since 2000 shortly thereafter.
Don’t forget these charts we showed you on July 3:
Ok, so that brings us to this morning’s Goldman note which begins with … drumroll… that very same damn chart. Well, actually it’s the spread, not the ratio , but you get the point:
And here’s some of the accompanying color and do note that “tech is now the largest sector in a ‘Low Vol’ proxy at over 14%” (!!)…
Decomposing Low Vol…past, present and future
The shift lower in Info Tech volatility has also driven a shift in the composition of “Low Vol” factor strategies. This can be seen in the weights of smart-beta ETFs such as the SPLV in which Tech is an increasing weight (12% vs. a 5-year average of 4% using quarter-end weights) as well as our Investment Profile (IP) Factor model, in which Tech now has the largest representation across the market (Exhibit 19). This current weight of 15% compares to an average weight of 6% over the last 5 years.
Factor characteristics have also changed. As we peer into Low Vol, we find stocks have high Size and Dividend Yield “scores”, suggesting names tend to be larger than average and offer higher yields. However, relative to history, Low Vol stocks are more skewed towards higher growth, stronger balance sheets and higher financial returns.
What is Low Vol not? Value. We find that Low Vol’s current skew towards Value is the lowest it has been in five years (current “score” of 42% vs. an average of 49%).
While “Low Vol” characteristics have likely drawn incremental flows into the sector, these can just as easily reverse.
Indeed, there are some signs that we have seen the lows of Tech volatility as the recent underperformance of the sector has contributed to a rise in both 3m and 6m measures though 12m realized levels remain below that of the S&P 500. Based on our calculations, if volatility for the lowest quintile of stocks mean-reverts to the 5Y average, volatility would move above the level of the S&P average. A caveat: the shock is likely to be muted as these companies would be removed from Low Vol strategies via rebalance.
Just let that last bit sink in for a minute.
If “low vol” names were to revert to their 5Y average, vol. would move above S&P vol. and the only thing that can save investors in low vol. products is the eventual rebalance.
Caveat fucking emptor.