Readers of this blog may be familiar with research by Stanford professor Joseph Piotroski categorizing companies according to balance sheet factors like return on equity and debt-to-equity ratios. The work is the basis for various epopular Morgan Stanley quant indexes and mirrors many inputs used by black-box momentum funds (like Cliff Asness’s, purely coincidentally, I’m sure). Here is what is going on according to that data since March 9:

The 130 companies in the S&P 500 and Europe’s Dow Jones Stoxx 600 Index with debt-to-equity ratios above 50 percent and a return on assets of less than zero in the most recently reported period rose an average of 121 percent from March 9 through May 9. That compares with a 32 percent increase for the S&P 500 and a 25 percent jump in the Europe Stoxx 600. Prior to this rally companies that Piotroski ranked highest outperformed the lowest-rated stocks every year but two since 1994.

This is tantamount to saying banks and consumer discretionary led the rally, since they obviously have the most dilapidated balance sheets. Still, an consequence of this kind of rally is that hitherto profitable momentum-following quant funds that were dead short those sectors are having some of their worst months in the history of the industry, comparable only, perhaps, to the experience of absolute return investors during Japan’s bear-market surges in 1992-93. One memo floating around Wall Street right now is that this situation remains extremely bullish in the short term — Japan’s rally ran to 50% as quants abandoned ship and tried to salvage their years by buying all the crap they could. That rally went to 50%. We’re at 34% on the S&P now.