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Leadership persists, losers lose big, dispersion rises

The outperformance of Tech and Comm Svcs and whether it can keep going has been a key source of debate amongst investors. We would point out that the end of each cycle has seen sector leadership persist, with the outperforming sector continuing to outperform until the very end of the market and economic cycle. This supports our continued positive view for the Tech sector medium-term.

Sector leadership has persisted in past cycles, until the end of the bull market. In the last cycle, Energy outperformed from before 2004 until the summer of 2008, six months into the recession. Before the 2001 recession, Tech outperformed until March 2000, before proceeding to take the equity market lower for years. Consumer Staples was the clear leader in the late 1980s and early 1990s while Energy was again a big outperformer in the late 1970s and early 1980s. Even earlier cycles saw the tendency for sector leadership to persist.

Figure 36: Staples led in 80s-90s

Figure 37: Tech led in the late 90s

0.20		Cons Staples vs SPX				0.50		Technology vs SPX
0.18	Curve					0.45	Curve
	inversion						inversion
						0.40
0.16						0.35
0.14						0.30
						0.25
0.12						0.20
0.10						0.15
86	87	88	89	90	91	95	96	97	98	99	00	01	02
Source: S&P, FactSet, UBS						Source: S&P, FactSet, UBS

Relative re-rating of Tech makes us tactically more cautious near term amid the potential for a reversal after the market derating.

Figure 38: Energy led through '08

0.50		Energy vs SPX
0.45	Curve
0.40	inversion
0.35
0.30
0.25
0.20
0.15
03	04	05	06	07	08
Source: S&P, FactSet, UBS

Figure 39: Factor returns through the phases of the ISM cycle (top minus bottom quintile, S&P 500 non sector neutral)

Low and rising ISM				High and rising ISM
-30%-15% 0% 15%30%				-10% 0% 10% 20%
Comp Value				Comp Growth
Comp Growth				Comp Momentum
Comp Quality				Comp Value
Comp Momentum				Comp Quality
Beta 12m				Beta 12m
Volatility 12m				Volatility 12m
Book/Price (trail)				Earn gwth fwd 1y
Total Debt to EV				Prc Mom 12mx1m
FCF Yield (trailing)				Earn Revision 3m
EY (NTM)				Sales gwth fwd 1y
Gross Prof mgn				Book/Price (trail)
Net Debt / EBITDA				Earn gwth trail 1y
Earn gwth fwd 1y				Gross Prof mgn
OCF margin				FCF Yield (trailing)
DY (trailing)				ROIC
Earn Revision 3m				EY (NTM)
EY (trailing)				Sales gwth trail 1y
ROIC				ROE
Short Interest				OCF margin
Earn gwth trail 1y				EY (trailing)
EBITDA margin				Market Cap
ROE				Total Debt to EV
Sales gwth fwd 1y				Sales Revision 3m
Sales gwth trail 1y				DY (trailing)
Prc Mom 12mx1m				EBITDA margin
Sales Revision 3m				Net Debt / EBITDA
Market Cap				Short Interest

High and falling ISM

-10% 0% 10% 20%

Comp Momentum Comp Quality Comp Growth Comp Value

Prc Mom 12mx1m

Earn gwth fwd 1y

FCF Yield (trailing)

Earn Revision 3m

Sales Revision 3m

Sales gwth fwd 1y

ROIC

ROE

Gross Prof mgn

Earn gwth trail 1y

Market Cap

OCF margin

EY (trailing)

Sales gwth trail 1y

EY (NTM)

EBITDA margin

DY (trailing)

Total Debt to EV

Net Debt / EBITDA

Beta 12m

Volatility 12m

Book/Price (trail)

Short Interest

Low and falling ISM

-30%-15% 0% 15%30%

Comp Quality

Comp Value Comp Momentum Comp Growth

FCF Yield (trailing)

EY (trailing)

DY (trailing)

ROE

ROIC

OCF margin

EY (NTM)

Gross Prof mgn

Prc Mom 12mx1m

EBITDA margin

Earn Revision 3m

Market Cap

Net Debt / EBITDA

Earn gwth trail 1y

Earn gwth fwd 1y

Book/Price (trail)

Sales gwth fwd 1y

Total Debt to EV

Sales Revision 3m

Short Interest

Sales gwth trail 1y

Beta 12m

Volatility 12m

Source: S&P, Compustat, IBES, FactSet, UBS

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At a factor level, momentum has been the best performing factor when the ISM was high/falling, corroborating the finding that momentum and leadership tend to persist at this stage of the cycle. Indeed, momentum worked well after the initial ISM peak in Feb-18 but unwound from Jun-Oct. After the ISM falls below the midpoint, momentum has not done as well.

Losers lose big: low price+EPS momentum performs the worst at this stage.

The underperformance of stocks with the lowest 12-1m price momentum and the lowest EPS+sales revisions has been sizeable (-8%) when the ISM was high/falling.

Quality tends to also do well, even until an ISM trough, in line with our finding that quality tends to do the best around and after rises in volatility (link). Our quant team also finds that quality performs well at this stage (link), and prefers a quality tilt currently. From a fundamental perspective, it makes sense that companies with higher margins, higher ROICs, better balance sheets and lower volatility tend to outperform as the cycle matures and competition tends to increase. Quality is the top performing style when the ISM is low and falling.

Growth stocks have outperformed on average until the ISM falls below 52, then performance reversed. Stocks with high forecasted EPS and sales growth have significantly outperformed when the ISM was high/falling. However, growth stocks then underperformed after the ISM crossed the midpoint and kept falling.

Value does not do well broadly, FCF yield and dividend yield does. Deeper value stocks with high book/price tend to underperform when the ISM is high/ falling. More expensive stocks have higher growth and tend to do ok at this stage. Value tends to do better at the later stages of the cycle.

Figure 40: Factor performance when ISM is high/falling

Figure 41: Factor performance when ISM is low/falling

-10%

-5%

0%

5%

10%

-30% -20% -10%

0%

10%

20%

High Earn gwth fwd 1y

High Comp Quality

High Sales gwth fwd 1y

Low Volatility 12m

High Comp Growth

High Gross Prof mgn

High Comp Momentum

High Comp Value

Low Comp Value

Low Beta 12m

High Gross Prof mgn

Low Book/Price (trail)

High Comp Value

High DY (trailing)

High ROIC

High ROIC

High DY (trailing)

High Book/Price (trail)

High Prc Mom 12mx1m

High ROE

High FCF Yield (trailing)

Low Short Interest

Low Short Interest

High FCF Yield (trailing)

High EY (trailing)

High Market Cap

Low Book/Price (trail)

Low Gross Prof mgn

High ROE

High EY (trailing)

High Market Cap

Low Sales Revision 3m

High Book/Price (trail)

Low EY (NTM)

Low Earn gwth fwd 1y

High Sales gwth trail 1y

Low ROIC

Low Comp Quality

Low ROE

Low Prc Mom 12mx1m

Low OCF margin

High Earn gwth trail 1y

High Short Interest

Low Earn gwth trail 1y

Low Earn gwth trail 1y

High Sales Revision 3m

Low Comp Quality

High Beta 12m

Low Sales Revision 3m

Low EY (trailing)

Low Market Cap

Low OCF margin

Low FCF Yield (trailing)

High Volatility 12m

Low Earn Revision 3m

Low FCF Yield (trailing)

Low Comp Momentum

Low Sales gwth fwd 1y

Low Prc Mom 12mx1m

High Sales gwth fwd 1y

Source: S&P, Compustat, IBES, UBS Note: Average annualized performance, 5th quintile (high) and 1st quintile (low) vs. median, non sector neutral.

Source: S&P, Compustat, IBES, UBS Note: Average annualized performance, 5th quintile (high) and 1st quintile (low) vs. median, non sector neutral.

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Dispersion tends to rise, and losers tend to decline by a lot more. Investors have been keenly focused on the outperformance of a few stocks ("FAANG", etc.) and the Tech sector. But dispersion between winners and losers was near all-time lows in 2017, but rose in 2018 as winners moved higher and laggards fell. In later cycle years, top performers tend to rally 30%+ and account for an outsized share of returns, while the worst performers tend to fall 20-40% (see FAANGs and breadth).

"Great convergence" is ending. The mantra for US stocks is no longer that "a rising tide lifts all boats" (or most boats…). Instead, while some "currents" are still going in, some are starting to go out and others have stopped going in. Corporates have taken on a more competitive mindset as disruptive technologies, increased M&A, a profit recovery, higher confidence and the search for top line growth has forced firms to be more proactive. QE and low interest rates have helped narrow the spread in earnings yields for stocks while the difference in expected 3-5yr EPS growth has risen dramatically. Active to passive flows have led to a jump in trading volume for mid and small size companies, also helping arb away valuation anomalies.

Figure 42: Stock performance begins to diverge more later in the cycle

We see leaders continuing to rally in 2019 as is typical outside of recessions. But we see the worst performers down by more than we saw in 2017 and this year prior to the Oct selloff.

The Oct selloff was exacerbated by active outflows, but we see the potential for passive selling in a downturn as a risk to less liquid stocks that will not have as much active support.

120%

100%

80%

60%

40%

20%

0%

								Spread of S&P 500 stock performance																In 2019, dispersion					60%
						Top - Btm 100 (avg)																		should rise from the
																									historical low
						Top - Btm 100 (wtd, rhs)																							50%
																								QE and zero rates					40%
																													30%
																													20%
																													10%
																													0%
59	61	63	65	67	69	71	73	75	77	79	81	83	85	87	89	91	93	95	97	99	01	03	05	07	09	11	13	15	17

Source: S&P, CRSP, FactSet, UBS Note: 5th quintile (top) minus 1st quintile (bottom).

Figure 43: Price momentum (12m ex 1m) by top and bottom quintiles, S&P 500

Figure 44: How many top 5 stocks are still in the top 5 a year later?

115%			Top quintile, non SN												3.0
			Bottom quintile, non SN													More consistent
95%															2.5
75%
55%															2.0
35%															1.5
15%
-5%															1.0
-25%
-45%															0.5		Less consistent
-65%
-85%															0.0
90	92	94	96	98	00	02	04	06	08	10	12	14	16	18	66	71	76	81	86	91	96	01	06	11	16

Source: S&P, CRSP, Bloomberg, UBS	Source: UBS Quantitative Research Note: We show the 24-month rolling average
	of the underlying time series, FAANGs and breadth.

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