Supply chain bottlenecks caused by COVID have clearly eased, and signs China is pivoting away from its zero-COVID policy helps that narrative. Daily news sentiment towards supply chains has rebound from its historical low and daily news mentions are dropping too, reducing its headline risk to markets. The NY Fed Global Supply Chain Pressure index also dropped sharply and is back to early-2020 levels.
To profit from the easing of supply bottlenecks, we construct the negative supply chain sentiment basket, which consists of the S&P names that expressed negatively on supply chain issue during their latest earnings calls, rebalancing quarterly. The names are more likely to be impacted by supply chain disruptions and shipping costs and as a result their stocks should benefit most from easing.
Our supply chain portfolio returns have been negatively correlated with freight prices and the NY Fed Supply Chain Pressure Index (SCPI). Though a good deal of easing has taken place, both freight costs and the NY SCPI remain above pre-COVID levels and have further to fall. The scope of gains to our portfolio has certainly narrowed, but supply chain sentiment has proven to be a good screening tool over the past quarter and should remain so until freight rates normalize.
As supply chain issue easing, less names are mentioning supply chain negatively, leading to the names falling in the basket drops to 38 relative to previous 59 names. We list the current basket at the end of the report. Excess returns to the portfolio since September has been driven most by Cap Goods and Retailing. The portfolio is overweight Cap Goods and Retailing and names from both industry groups have outperformed. After we rebalanced the portfolio, incorporating 3Q sentiment readings, the portfolio is less weighted to Cap Goods and more weighting on Food & Tobacco and Energy.
The factor exposure of rebalanced negative supply chain is more risk-off exposed. Though the easing of financial conditions is a macro headwind to risk-off factors, the outperformance of the portfolio suggests that fundamental recovery from supply chain easing is adding more than the factor profile is taking away.
Supply Chain Easing Supporting Negative Sentiment Portfolio: Supply chain bottlenecks caused by COVID have clearly eased, and indications China is pivoting away from its zero-COVID policy helps that narrative. Daily news sentiment towards supply chains has rebound from its historical low and daily mentions are dropping too, reducing its headline risk to markets. The NY Fed Global Supply Chain Pressure index also dropped sharply and is back to early-2020 levels. Easing supply chain pressures are alleviating goods price inflation pressure as well.
Companies are feeling less the pressure from supply chain issue today as well. Supply chain sentiment of S&P managers expressed during 3Q earnings, which we measure using the Amenity natural language processing tool (if you want to learn more about the tool just let me know) rebounded sharply and it again net positive. Another driver for inflation, commodity prices, have also dropped, and the sentiment toward commodity prices is well off its low.
To profit from the easing of supply bottlenecks, we construct the negative supply chain sentiment basket, which consists of the S&P names that expressed negatively on supply chain issue during their latest earnings calls, rebalancing quarterly. The names are more likely to be impacted by supply chain disruptions and shipping costs and as a result their stocks should benefit most from easing. The indexed performance of the portfolio has been negatively correlated with freight prices over time. Freight prices have come down but remain about their pre-COVID level and NY Fed Global Chain Pressure Index remains near its 90th percentile, leaving room for negative supply chain names to post further gains, though at a lesser extent.
Over the past 3 months, the portfolio gained 23.5% annualized excess return relative to the S&P, posting gains on 58.7% of days. The beta has been roughly in line with the S&P with a sharp ratio of 1.26.
The excess return for the previous quarterly basket has been driven by Cap Goods and Retailing names. Telecom and Pharma were drags on the portfolio. The basket remains VERY overweight Cap Goods and Retailing, and names in the portfolio from both industry groups outperformed. These are industries more likely to be impacted by supply chain issue as well.
We rebalance the portfolio based on 3Q earnings call sentiment readings. As supply chain issue ease, fewer companies are mentioning supply chain negatively, leading to fewer names falling into the negative basket. Total positions dropped from 38 relative to 59 names in the 2Q basket. The decline in stocks also means more concentrated sector/industry exposure. The rebalanced portfolio is less weighted to Cap Goods while is more weighting on Food & Tobacco and Energy.
The factor exposure of the rebalanced negative supply chain portfolio is MUCH more risk-off with Relative Size, Low Volatility, and Growth Momentum the leading factors. The portfolio is negatively exposed to Earnings Turbulence, Realized Value, and Liquidity factors. Easing of financial conditions is a macro headwind to risk-off factors, but the outperformance of the portfolio suggests screening for leverage to easing supply bottlenecks is overpowering that factor drag.
Below we list the companies expressing the most negativity about supply chains in their latest 3Q earnings calls, and currently falling into the negative supply chain portfolio. They should recover more as supply chain bottlenecks continue to improve.
