Stock upside down? Covid-1 Beta Beta effect

The coronavirus epidemic has reversed around the world and with it the fundamental nature of the stock price movement.

As the equity market peaked on February 20, 2020, the underlying fundamentals of regulatory risk in the market somehow stopped over its head. Stocks in the technology, pharmaceutical and biotech sectors, for example, are used to increase market volatility – rising higher when the market rises and falling further when it falls. But in the Covid-1 market, they actually show less volatility. At the same time, stocks that previously had a damp effect – defensive and mining stocks, say – and have retreated into a spiking or declining market, now have sharp ups and downs.

This change not only reverses the relationship between risk and reward, but also has a profound effect on how investors diversify their holdings and think about portfolio risk reduction and mitigation.

In financial terms, the relationship between an equity return and the overall market is measured by beta. Systemic risk is higher than the overall market for stocks with beta above 1.0. So if the market – here the S&P 500 – rises 1%, risky stocks like high beta, technology, pharma and luxury goods companies will rise more than 1%. Conversely, if the S&P 500 falls 1%, they will fall further.

And yet, since the coronavirus has taken over the crisis, these try-and-true relationships have been reversed.

We analyzed daily US equity data from February 20 to June 1 to see how much has changed with certain sectors and the risks they have created in a portfolio.

Technology and Work from Home (WFH) organizations specifically show how deep the ocean has changed. These WFH companies include Work from Home Exchange-Traded Fund (ETF) (Ticker: WFH) and others, including Zoom, Slack, Amazon and Dropbox. In a new lockdown of coronaviruses, as more people work remotely, their incomes probably expand.

Coronavirus-induced beta inversion

Coronavirus beta 2019 beta Beta changes
Work from home (WFH) 0.90 1.35 -0.45
Pharmaceuticals 0.81 1.11 -0.30
Information technology 1.11 1.37 -0.26
Healthcare 0.90 0.98 -0.08
Communication service 0.90 0.97 -0.07
Art 1.07 1.14 -0.07
Materials 1.08 1.06 0.02
Consumer considerations 1.19 1.06 0.13
Power 1.44 1.26 0.18
Consumer staples 0.73 0.54 0.19
Financial 1.30 1.06 0.24
Accommodation 1.16 0.44 0.71

The beta shift is dramatic. For example, Zoom went from a beta of 1.82 in 2019 to -0.36 during a four-month epidemic period. What does that mean? In 2019, if the S&P 500 grows 1%, the zoom will increase by an average of 1.82%. Now, when the market increases by 1%, the zoom decreases by 0.36%.

Good news for the market, bad news for Zoom.

The beta board for companies in the WFH sector has fallen across. Amazon’s beta of 1.33 in 2019 dropped to 0.60 during the four-month sample period. Dropbox went from a beta of 1.43 last year to 0.77. Everyone said that the average beta of WFH company has come down from 1.355 in 2019 to 0.9090. And the average beta of all IT companies has dropped from 1.37 to 1.11.

And technology is not the only sector where instability has declined. The beta of pharmaceutical and biotech companies has also declined. For example, Modern had a beta of 1.33 last year. During the coronavirus period it drops to -0.03. Combined pharmaceutical and biotech companies dropped their average beta from 1.11 to 0.81 in 2019.

After all, what will happen to companies with negative beta? How did the Covid-1 effect affect them? The share price of the rare negative beta firm moves towards the overall side of the market, falling when the S&P 500 rises and speaking when the index falls.

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Of the two negative5 companies listed on the NYSE / Nasdaq last year, there were negative betas, half of which were in the mining and extraction sectors. Only 5% were in pharmaceuticals. This year, these numbers have been completely reversed: mining stocks accounted for only 5% of negative beta stocks, pharmaceuticals more than 50%.

The Capital Asset Pricing Model (CAPM) recommends that the higher the beta, the greater the likelihood of an external return in the long run. The whole 180 of how companies move with the market means that we need to rethink how we approach risk and return. Safe companies are now risky and risky companies can be safe.

Investors need to be careful. When balancing our portfolios, stocks in so-called low-volatility sectors can actually increase our risk and vice versa.

This is the new reality in this Topsy-Tarvi coronavirus world.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Photo Credit: © Getty Images / Ian Christopher Lava / IEM

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Derek Horstmeyer

Derek Horstmeyer is a professor at George Mason University School of Business, an expert on exchange-traded funds (ETFs) and mutual fund performance. He currently serves as director of the new head of financial planning and asset management at George Mason and established the first student-led investment fund at GMU.

Chaitanya M. Biz

Chaitanya MBS is a student who has a special interest in investing energy and data analysis and impact for financing. He is currently pursuing a bachelor’s degree from George Mason University and is exploring various roles in finance, from banking to money management.

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