What is behind the current market craze? Sure, it’s Trump and tariffs. But what does the market look like regarding investment indicators/factors? We’ll find out in the current edition of our TAOTS. We will also look at how to hedge against these downturns.
MARKET DRIVERS
The biggest market movers in March 2025 were momentum factors, which are working exactly against their long-term trend in current market conditions. For example, the 10 stocks with the highest PLUS DI 756 values over the past 10 years have risen 582% compared to “only” 116% for stocks on the other side of the spectrum. However, in March, the situation reversed and the stocks with the lowest values of that indicator performed significantly better.
When constructing a portfolio, it is wise to work with this kind of information about the characteristics of the investment indicators and to manage the risks of the portfolio appropriately by combining multiple factors.
But in early April, the markets have fallen in such a way that even the “anti-system” factor, or for example, longing stocks with low PLUS DI 756 values, will not be a way to save investors.
SHORTING
In times when entire markets are falling, shorting is the method that is emerging at the forefront of investors’ minds. In the current edition of our newsletter, we will, therefore, explore the creation of a two-factor portfolio that uses a short leg. A properly composed long/short portfolio is a way to neutralize the market crisis.
The premise of our portfolio construction is that we cannot predict market declines and for this reason, we are 100% invested in stocks at every moment. As the markets are rising over the long term, we select a 60% Long exposure and a 40% Short exposure for our strategy. We use our Factor investing app where we can easily change all parameters to gather answers and create investable multi-factor portfolios.
For our analysis, we consider the Long leg of the stocks with the highest Autocovariance 10 value and the Short leg of the stocks with the highest Free Cash Flow value. We evaluate the results over the last 3 years.
LONG/SHORT PORTFOLIO RESULTS
As we can see from the chart, in terms of a final return, it has been worth investing in stocks with a high Autocovariance 10, but this year’s 20% drop has been quite painful for investors.
Shorting alone would cause a loss over the entire period of use, so using solely this strategy does not make much sense.
However, by compositing the two indicators and forming a two-factor portfolio, we can achieve interesting results where the compound performance (148%) has significantly outperformed the S&P 500 benchmark while showing very little drawdown (under 7%).
The risk profile of each investor determines the answer to the question in the headline ‘Is shorting worth it?’, but the results clearly show the advantages and disadvantages of each approach.
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