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Financial flexibility – a company’s ability to handle shocks to cash flows – plays a crucial role in determining corporate capital structure and financial decisions. Despite its importance, there is a lack of well-established definition financial flexibility and limited empirical study on its return predictability. Financial flexibility is not directly observable, determined by corporate management decisions, which makes it difficult to model and measure.
On the back of rising global trade conflicts, Brexit and geopolitical tensions, the ECB recently hinted that it may restart the QE to stimulate the economy and push inflation higher. The Fed also indicated that it may lower interest rates as early as July. While the market has high anticipations about a new round of strong monetary stimulus, it is far from certain at this point that the central banks will act as aggressively and quickly as what investors are hoping for.
In a recent publication, we discussed a phenomenon known as Quadrophobia (see Rounding Errors Jussa, et al ). It’s a phenomenon where company management is likely incentivized to round EPS upwards. We find there is a significant underrepresentation of digit four in the third decimal place in calculated EPS. Our findings show that Quadrophobia is pervasive in the US market and likely a result of accounting distortion by company management.
In today’s video brief, we discussed the challenges and opportunities facing active managers. In particular, we suggest quantamental investing via industry-specific modeling is likely to add alpha and diversification benefit. Then, we use our global real estate research as an example to show how to incorporate domain knowledge, unique alternative data, and machine learning to develop sector-specific models. We also briefly discuss our global energy stock-selection model Malessa, global banking model BALI, and global TMT model Talia.
The US-China trade talks unexpectedly fell apart in early May. The tension between the two largest economies quickly escalated. US raised tariffs on Chinese goods and added Huawei, the Chinese telecom giant, to the “Entity List”. China retaliated with increased duties on US imports and proposed its own version of “Unreliable Entity List”. Despite the worsening market sentiment, President Trump started a new trade fight on another front, threatening to raised tariffs on Mexico in an effort to curb immigrant inflows.
Wolfe Research Vice Chairman and Head of QES Research, Yin Luo, hosted a webcast to discuss how our custom risk models and portfolio analytics can be used to understand the risk and return profiles of typical active portfolios. Next, using one of our most popular global stock selection models – the SHIELD. The SHIELD model is designed to help investors avoid downside equity market risk, while preserve the upside participation if the equity market rallies. Lastly, we demonstrate how investors can tilt their portfolios towards the SHIELD in their existing structure.
In finance and accounting, it is more about direction than absolute accuracy in most occasions, i.e., accounting materiality. For example, in the US, reported EPS is almost always rounded to the nearest cent rather than showing six decimal places. This seemingly innocent numerical rounding rule, however, may have serious unintended consequences. Company management is far more likely to be incentivized to round EPS upwards, a phenomenon known as Quadrophobia. We find there is a significant underrepresentation of digit four in the third decimal place in calculated EPS. Our findings show that Quadrophobia is pervasive in the US market and likely a result of accounting distortion by company management.
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