Return Of Alpha As Correlation Decreases?

Updated on

Alpha emphasized in 2014

Citi analysts believe alpha may become more important in 2014 as correlations are falling. In this environment, stock pickers have favorable conditions as the global economy is in the middle of a recovery

In Citi’s view, global economic output will improve relative to prior years. Such growth may support a 9% increase in global earnings per share (EPS) this year. Global EPS growth has been stagnant for the past few years; thus a faster growth outlook is encouraging. Citi analysts also estimate that global equity markets could return around 9% for 2014.

Higher risk appetite

Jonathan Stubbs, Citi’s strategist for Europe, believes that companies that offer more exposure to risk may generate better returns this year. Mr. Stubbs highlights that there is a lower likelihood of downside macroeconomic risks in Europe, market risk or beta is attractively priced and fundamentals (i.e. balance sheets, earnings growth) of stocks exposed to market risk have improved.

Citi’s European stock screen focus on names exposed to market risk and economic growth with improving earnings trends and attractive pricing. Citi analysts also ran the screen globally outside of Europe. Note that financials and cyclicals dominate the list, while defensive names are notoriously absent.

REV screen

Return of capital

Tobias Levkovich, Citi’s U.S. strategist, prefers companies that return capital to their shareholders by shrinking their available shares consistently. He notes that share buybacks alone are not effective in shrinking share count as management may increase shares outstanding by offering option grants or by financing acquisitions using stock.

Mr. Levkovich believes that consistent share shrinking may continue to generate excess returns this year. U.S. companies still have cheap debt financing and healthy balance sheets that could fund further share shrinking. Tobias ran a screen on the S&P 500 to focus on the largest companies that have reduced their share count over the last 5 years. Worldwide, the screen was broadened to include stocks within the MSCI AC World that shrank their shares during 4 out of the past 5 years.

share shrinkers screen return of capital

Similarly, Citi’s Japanese strategist, Kenji Abe, also seeks firms that are more likely to return capital to shareholders. He prefers stocks with low return on equity (ROE) and strong balance sheets, which could profit from economic recovery and also afford to repurchase shares and increase dividends.

Leave a Comment