Friday, Apr 17th 2020

It's all about the skew


Bet big when the odds are in your favor. Here's one way to estimate them.

In a note to clients yesterday, we advised investors to be patient in deploying capital following the stock market's recent run-up.

While many Wall Street strategists have come out recently with very bullish outlooks for the year, we see a more neutral upside/downside "skew" to U.S. stocks today. We believe that investors can afford to be selective in deploying capital over the coming weeks/months (i.e. light offense).

"Skew" refers to the balance between the potential positive and negative event paths at a given point in time. More simply, it's the ratio of upside vs. downside.

This is a useful framework in investing because it can help you bet big only when the odds are in your favor (vs. when the market is just giving you a coin toss).

See a stock with 60% upside and 20% downside? That's a 3:1 skew (quite good; stock could be a buy). Another with 10% upside and 20% downside? That's a 1:2 skew (quite poor; maybe the stock is a short?).

Now, you cannot just go online to find the upside vs. downside for the S&P 500 or a given stock. Investors have to do their own homework to estimate them. This is what our Research team does for you. And today, we estimate the short-term skew for the S&P to be quite balanced (1:1).

So in the short term, the odds are roughly even. Short-term even odds coupled with long-term excellent odds warrant light offense. Light offense means spreading out your buys and keeping some dry powder if/when the market reprices the downside risks more appropriately.

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