How COVID-19 Has Impacted U.S. Stock Residuals

The spread of the novel coronavirus has impacted the health, wealth, and lives of so many across the globe. The widely established lockdowns and social distancing measures have resulted in layoffs, furloughs, business closures, and an economic slowdown. Over the past nearly two months, investors felt the impacts on the financial markets, and everyone is starting to understand more about the pandemic’s effect on the economy as figures like retail sales, GDP estimates, and jobless claims are released. For further insights, Venn has written a good deal on the factor return impact in Venn Factor Performance Reports.

For the analysis period covered in this post (February 24th - April 14th), we know that the overall stock market has declined: the global Equity factor in Venn hit its maximum drawdown of -31% on March 23rd, and the U.S.-centric S&P 500 Index similarly reached -33% on that same date.¹ But which stocks have disproportionately suffered or gained beyond what their factor risks suggest? We can measure this by the performance of their residuals, or the returns that cannot be attributed to the stock’s exposure to common risk factors such as Equity. As we’ve mentioned before,² an investment’s or portfolio’s residual (sometimes referred to as “alpha”) is highly dependent on the factor model used to measure it. We will be using the Two Sigma Factor Lens, the group of risk factors Venn uses to analyze multi-asset class portfolios and individual securities.³

Which stocks were most impacted (over and above factor exposures) by the spread of the coronavirus, as measured by their residuals? We have ex-ante expectations of which stocks were impacted most by COVID-19: those industries / sectors that are talked about in the news, such as airlines and restaurants on the negative side, and health care, grocery stores, and food delivery on the positive side.⁴ We’ll see whether the actual results hold up when examining stocks’ residuals.

Here are the top and bottom 25 stocks in the S&P 500 according to their residual returns using the Two Sigma Factor Lens for the period February 24, 2020 - April 14, 2020.⁵

Exhibit 1: Top and Bottom 25 Residual Returns of Stocks in the S&P 500 Index

Source: Venn as of April 15, 2020. Time period: February 24, 2020 - April 14, 2020. 

While we won’t cover every stock in the table above, we observe the following themes, as well as some interesting outcomes that may be worth exploring in more detail:

• More people are staying at home as a result of widely enacted social distancing measures to slow the spread of the virus. Examples include:
  • Employees working from home may require remote access to their work networks, boosting the residuals for Citrix (software company that supports remote work) and Equinix (an internet connection company).
  • Other software companies, such as Autodesk (software for construction, engineering, and other industries) and Salesforce (customer relationship management software), did not benefit, potentially because of caution about any new discretionary business expenditures.
  • Live Nation, an events promoter and venue operator, exhibited a negative residual, likely due to the fact that there aren’t any concerts or events scheduled in the near-term. 
  • Travel restrictions and lower travel demand have likely negatively impacted the residuals of airline stocks, such as Delta and American Airlines, Boeing, and even hotel chains like Marriott.
  • Less spending, as evidenced by March’s record decline in retail sales,⁶ hurt Mastercard’s residual. Visa also experienced -11% residual returns.

• Unfortunately the effective shutdown of many economies has resulted in job layoffs, furloughs, and business closures, which is likely impacting Paycom (software solution for payroll and human resources) and potentially Fleetcor (business payments company). 
• As mentioned earlier, we see certain healthcare companies prospering, such as Humana and Universal Health Services, in or just outside the top 25.⁷
• Many people stocked up on food, cleaning supplies, and other items (read: toilet paper) in early March as the world came to grips with the coronavirus pandemic spreading globally. You see this come through in the positive residuals for companies like Dollar General, Walmart, and Clorox.
• The net increase in the price of gold as investors sought “safe-haven” assets amid the market panic likely supported the residual of Newmont (the world’s largest gold mining company). 
• Oil prices collapsed over 50%, impacting energy-related companies.⁸ It’s interesting then that Chevron and four other companies with “Energy” in their name are in the top 25.
  • While the stocks of Noble, Diamondback, and Devon (all hydrocarbon exploration companies) have experienced approximately 60% drawdowns over this period, their residuals have been positive. Their recent betas to the Equity and Commodities factors have been large (a range of 1.5 to 2.6), meaning that the stocks have historically captured 1.5 to 2.6 times the returns experienced in both stock and commodities markets. The stocks’ prices have actually fallen less than what that would imply, contributing to the positive residual returns.
  • Eversource Energy is an electric services company offering retail electricity, gas, and water to people in the Northeast, who are likely running higher electric bills due to staying at home for more hours than normal.

Finally, not every stock in the top and bottom 25 has an obvious link to what’s been happening in the world as a result of the spread of COVID-19. Looking at residuals can be a way to find stocks (or managers or other investments) that have "gone under the radar" as COVID-19 has dominated the news. Researching these further could be a more interesting exercise for investors versus some of the more obvious impacts discussed above.

We’ll end by showing how you can visualize a stock’s residual by plotting its cumulative contribution to the stock’s total return over time. Here’s an example using Newmont (the gold mining company).

Exhibit 2: Cumulative Residual Return of Newmont Corp

Source: Venn as of April 16, 2020. Time period: April 15, 2017 - April 14, 2020. 

If you are interested in analyzing the residual returns of other stocks, your managers, and/or your portfolio, check out Venn’s recently added residual analysis blocks that can help you better understand residual performance trends and history.⁹

REFERENCES

¹Source: Venn.

²See One Investor’s Alpha is Another Investor’s Risk.

³It’s important to note that the Two Sigma Factor Lens does not break out the macro factor exposures (such as Equity or Commodities) into various sectors, industries, or countries. Therefore, the residuals could also be a result of tilts toward certain equity industries or commodity sectors, for example. For more information on why the lens does not include these types of factors, read Applying Occam’s Razor to Factor Analysis.

⁴Sources: USA Today article “Industries hit hardest by coronavirus in the US include retail, transportation, and travel” on March 20, 2020, and NPR article “The Coronavirus Pandemic Hurts Some Industries, Benefits Others” on March 24, 2020.

⁵Source: Venn, using the last 3 year exposures to the factors in the Two Sigma Factor Lens to calculate the stocks’ residual return contributions.

⁶Source: Bloomberg article “U.S. Economic Data Show Deep Hit in March, Collapse in April” on April 15, 2020.

⁷Source: Venn, using the last 3 year exposures to the factors in the Two Sigma Factor Lens to calculate the stock’s residual return contribution.

⁸Source: Trading Economics Crude Oil WTI.

⁹The new residual analyses are available to Venn Pro users only.

This article is not an endorsement by Two Sigma Investor Solutions, LP or any of its affiliates (collectively, “Two Sigma”) of the topics discussed. The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma. This article (i) is only for informational and educational purposes, (ii) is not intended to provide, and should not be relied upon, for investment, accounting, legal or tax advice, and (iii) is not a recommendation as to any portfolio, allocation, strategy or investment. This article is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. This article is current as of the date of issuance (or any earlier date as referenced herein) and is subject to change without notice. The analytics or other services available on Venn change frequently and the content of this article should be expected to become outdated and less accurate over time. Any statements regarding planned or future development efforts for our existing or new products or services are not intended to be a promise or guarantee of future availability of products, services, or features.  Such statements merely reflect our current plans.  They are not intended to indicate when or how particular features will be offered or at what price.  These planned or future development efforts may change without notice. Two Sigma has no obligation to update the article nor does Two Sigma make any express or implied warranties or representations as to its completeness or accuracy. This material uses some trademarks owned by entities other than Two Sigma purely for identification and comment as fair nominative use. That use does not imply any association with or endorsement of the other company by Two Sigma, or vice versa. See the end of the document for other important disclaimers and disclosures. Click here for other important disclaimers and disclosures.