Genus Quantitative Insights - July 2009

Quantitative Insights Vol. 1, No. 02— July, 2009

Sharp u-turn from momentum to value

A

lthough we anticipated the beginning of a new value regime as the economy troughed, the ferocity of the shift away from momentum in the second quarter surprised us. We did not expect it would happen this quickly.

E

xhibit 1 shows our research into investment style performance and the four-year rotation between momentum and value strategies. A momentum-driven market has historically preceded a recession, and worked well through it too. Once a recession nears its end, the market typically switches its focus to valuations and risk taking. This has happened in every one of the past five recessions going back 40 years. In the first quarter of 2009 we observed that momentum had started to give way to value. However, the speed at which value roared back surprised us. A powerful deep value (Book/Price) rally, coupled with risk-taking (leverage and volatility) , drove market performance in the second quarter.

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xhibit 2 shows the outperformance of value factors in the second quarter (red bars) and the sharp reversal in factor performance versus the 12 months from March 2008 to March 2009 (blue bars). On the flip side, momentum was crushed in the second quarter, down almost 40%.

Exhibit 1: Momentum / Value Rotation Accelerates Sharply 1.0%

Momentum relative to Value: 48-month moving average

0.8%

Momentum outperforms

0.6% 0.4% 0.2% 0.0% -0.2%

Value outperforms

-0.4% -0.6%

87

91

93

97

00

04

08

09

Source: Genus Institutional Equity

Exhibit 2: Stock Selection Factor Performance — Canada 2nd Quarter 2009

March 2008—March 2009

B o o k/P rice EB ITDA /Enterprise Value Cash Flo w/Enterprise Value Dividend Yield P rice/Earnings Interest Co verage Return o n Equity 2-Year EB ITDA Gro wth Size Share Repurchase Earnings Surprise Lo w Vo latility Lo w Leverage Quarterly Dividends Quarterly Cash Flo w A nalyst A greement A nalyst Estimate Revisio n 6-M o nth P rice M o mentum 11-M o nth P rice M o mentum -40%

Source: Genus Institutional Equity

-30%

-20%

-10%

0%

10%

20%

30%

Quantitative Insights

40%

1

Quantitative Insights

E

xhibit 3 shows the performance of our Bear Market Recovery (BMR) Index for the 12 months ended June 30, 2009. The BMR Index is an equal-weighted composite of four attributes that include high risk, low quality, low momentum and deep valuation. Riskier stocks scored big gains in the past six months while higher quality stocks, those with the least risky attributes, have lagged. While risk attributes can provide sizeable rewards in economic recoveries they underperform in the middle of the economic cycle and do not produce excess returns over a complete market cycle.

Exhibit 3: High Risk Stocks Score Big Short-Term Gains Genus Bear Market Recovery Index 6/30/08-7/20/09 -210 -220

+50%

-230 -240 -250 -260 -270 -280 Jun 08

Jul 08 Aug 08 Sep 08 Oct 08 Nov 08 Dec 08 Jan 09 Feb 09 Mar 09 Apr 09 May 09 Jun 09

Source: Genus Institutional Equity

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xhibit 4 shows that over the longer term the opportunity for high risk stocks is limited. Although there are periods when the BMR Index outperforms, typically into a recovery (93/94, 98/99, 02/03 and 08/09 ) over the longer term these attributes do not add value. Their point of maximum risk/reward is when the market is coming off its worst (See insert: Exhibit 3). Their performance will likely continue to wane in the next few quarters as investors gain confidence in fundamentals and start focusing on high quality stocks, earnings-driven valuations and positive long-term price momentum—attributes that typically provide superior returns over an entire market cycle.

Exhibit 4: Bear Market Recovery Index Cumulative Returns 50

BMR Index: Equal-weighted composite of four attributes that include high risk, low quality, low momentum and extreme valuation.

0 -50 -100

The performance of risky stocks in the past six months has been well above their historical relative norm.

-150 -200

Exhibit 3

-250

Dec.92 Jun 93 Dec 93 Jun 94 Dec 94 Jun 95 Dec 95 Jun 96 Dec 96 Jun 97 Dec 97 Jun 98 Dec 98 Jun 99 Dec 99 Jun 00 Dec 00 Jun 01 Dec 01 Jun 02 Dec 02 Jun 03 Dec 03 Jun 04 Dec 04 Jun 05 Dec 05 Jun 06 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09

-300

Source: Genus Institutional Equity

Quantitative Insights is published quarterly by Genus Institutional Equity, a division of Genus Capital Management 6th Floor~900 West Hastings St., Vancouver, BC, Canada V6C 1E5 T 604 683 4554 www.genuscap.com