Algorithms could create unusual rotations in equity markets

Unusual rotations seen in global equity markets could be driven by algorithmic trading, which might lead to highly erratic markets and create a double-edged sword for investors, according to new findings from a Montgomery Global Investment Management whitepaper.

Andrew Macken and Christopher Demasi from Montgomery explained in their analysis that non-fundamental moves in stocks created mispricings for active managers to take advantage of, and more opportunities for long-term investors who could tolerate some degree of volatility.

According to the study, this would mean that short-run performance metrics were less meaningful.

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The whitepaper also aimed to prove that the uncomfortable environment of falling stock prices would make them less risky.

“In this whitepaper, we show that global equities have delivered real returns of approximately zero over the last four years (excluding the Trump tax cut). Yet, over this period, pre-tax earnings have grown significantly,” the study said.

“This implies that stocks are relatively cheaper and have arguably become less risky, over the last four years, not more.”

According to the firm’s analysis, approximately 70 per cent of US equity returns over the last four years was driven by the reduction in the US corporate tax rate.

“Absent this tax cut, US equities would likely have delivered an average return of 1.9 per cent per annum – exactly the same as the average yield of the %YR US Treasury bond over the same period,” the study said.

It also proved that despite global equities drifting sideways, absent the one-time Trump tax cut, the pre-tax earnings were actually higher, which meant that global equity markets became heaper, or less risky, over the last your years.

Such a volatile environment would create more opportunities for active managers who could exploit stock-specific mispricings to generate outperformance to the average equity market return.

“In a lower-returning and more volatile equity market, investors should favour high-quality active fund managers over their passive counterparts.”

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