2024 Year in Review

Factor Influence and Market Volatility Review

2007 - Present: Classifying “Factor-Driven” and “Alpha-Driven” Markets

‍This analysis will focus on the US market using our US Extreme Movers Portfolio. The portfolio is a weekly-rebalanced, market-neutral portfolio that invests long in the top decile of best performers and shorts the bottom decile of performers in the Russell 1000 index. The characteristics and performance of the Extreme Movers Portfolio point to the areas of the market that were in and out of favor and provide valuable insight into themes that drove stock returns.

Our US Extreme Movers portfolio began on Jan 1, 2007. Each week, we observe performance decomposition through the lens of various risk models and use quintiles to categorize the performance on a spectrum of the most “Alpha-Driven” weeks to the most “Factor-Driven” weeks. To calibrate our classification, we took the total sample of all weeks (>930) since Jan 1, 2007, and ranked them by Alpha Contribution to return percentage.

‍A Very Alpha-Driven Week (Top Quintile) is one where an Alpha Contribution to return is HIGH and a Very Factor-Driven Week (Bottom Quintile) is one where Alpha Contribution to return is LOW.

‍Below are the Alpha Contribution thresholds that define the quintiles:

In addition to understanding what portion of the market volatility was attributable to factors and alpha, we also need to proxy the market volatility levels. We applied the same ranking methodology to categorize the volatility of weekly periodsbased on the total return of the US Extreme Movers portfolio. We categorized these quintiles from “Very Volatile” to “Very Calm.”

To break down the historical context, we segmented the historical data by calendar year and market regime to give investors a sense of how the recent and current market stack up against prior periods. Details on the thematic market regimes are below.

‍Aggregating Weeks into “Alpha-Driven” vs. “Factor-Driven” Periods

‍The availability of alpha in the markets is critical for fundamental investors. Historically, there have been periods during which the majority of volatility in the market was attributable to stock-specific nuances. These periods provide ample opportunity for stock-pickers’ competitive advantage to shine. There have also been periods that were clouded by market factors, restricting the fundamental investor’s ability to drive idiosyncratic returns.

Here, we’ve broken down the weeks in each year since 2007 according to our spectrum of “Very Factor-Driven” to “Very Alpha-Driven” and examined the percentage of weeks in each category. In doing so, we found that only 31% of the weeks in 2024 were at least “Factor-Driven,” which is down 8% compared to 2023 and is the lowest percentage observed since 2014. Conversely, 45% of the weeks were at least “Alpha-Driven,” which is an almost 50% increase from 2023 and is the highest level seen since 2010-2014. This means that bottom-up, fundamental stock-pickers were much better positioned this past year to uncover opportunistic stocks whose prices weren’t over-influenced by market and macroeconomic forces.

When comparing to market regimes, we can see that 2024 presented significantly more alpha opportunity than the most recent “Rate & Inflation Downturn” period. It also surpassed the Q4 2018 and COVID periods, which presented significantly less alpha opportunity and more factor influence than the most recent year. Interestingly, the Post-GFC Pre-COVID era was the most similar period in terms of distribution of weeks, though 2024 had slightly more “Neutral” weeks and slightly fewer “Very Factor-Driven” weeks.

‍Aggregating Weeks Into Volatile vs. Calm Periods‍

Beyond the breakdown of Extreme Mover's performance into factor and alpha, another key area we looked at was the overall level of volatility. The charts below aggregate each week since 2007 on a scale of from "Very Calm" to "Very Volatile," across calendar years and market regimes. We found that 33% of weeks in 2024 were "Volatile", which is closely in line with what was seen in 2020, 2022, and 2023. There were an additional 27% of "Very Volatile" weeks, reaching an aggregate level of 61% that has only been exceeded in 4 out of the last 18 years. The percentage of "Calm" or "Very Calm" weeks in 2024 was 10%, which again aligns with 2020, 2022, and 2023.

When compared to past regimes we can see that 2024 was still a year of elevated volatility, aligning with the periods that had the fewest “Calm” and “Very Calm” weeks - namely, the Global Financial Crisis, COVID, and the Rate & Inflation Downturn. That said, the number of “Very Volatile” weeks in 2024 was markedly lower than any of these three regimes, indicating a slight decrease in the level of volatility we’ve observed in recent periods.

‍Elevated Volatility with Factor Influence

‍To round out our analysis of the US Extreme Movers factor influence, we wanted to identify the cross-section between considerably factor-driven and considerably volatile periods over the past year. In other words, "how often was the US market heavily volatile because of factors?" The intersection of these two categories represent periods where alpha is far less available, but stock prices are experiencing significant price movements, creating a challenging environment for fundamental investors.

The chart below presents the percentage of weeks each year categorized as at least "Factor-Driven" and at least "Volatile." When framed in this context, we can see that 2024 had the same number of "Factor-Driven" and "Volatile" weeks as 2023, which had been a sharp reduction from the year prior. However, there were only 4% of weeks in 2024 that were “Very Factor-Driven” and “Very Volatile”, which was a reduction of 6% compared to last year. In aggregate, 2024 had the least periods of heightened factor-driven volatility since prior to 2020. Of the years in our analysis, 2024 was most similar to 2015 and 2023.

In comparison with past regimes, 2024 saw less than half of the factor-driven influence of COVID and the Rate & Inflation Downturn, and was lower than all regimes except for the Post-GFC + Pre-COVID era. It most aligned with the Q4 2018 period, sharing a similar level of “Factor-Driven” and “Volatile” weeks, with slightly fewer “Very Factor-Driven” and “Very Volatile” weeks.

Given the reduction in factor-influenced volatility compared to recent years, we also examined periods where elevated volatility in the US Extreme Movers portfolio was driven by alpha, which represent periods that are rich in opportunity for fundamental investors. 2024 saw the highest number of at least “Volatile” and at least “Alpha-Driven” weeks since the inception of this portfolio, with 27% of the weeks falling in this area. Of that, 18% of weeks were “Volatile” and “Alpha-Driven”, which is a 6% increase from 2023 and is only surpassed by 2008 and 2012. There were an additional 10% of weeks that were “Very Volatile” and “Very Alpha-Driven”, which is a 2% increase from 2023 and is the highest level seen since inception.

Extreme Movers Exposure Analysis

Sector Summary

Broadly, what we found in reviewing sector behavior in 2024 was that sector allocations diverged strongly based on “up” versus “down” markets. We measured “up” and “down” markets based on the weekly return of the US Country factor.

Financials emerged as the most favored sector in the U.S. Extreme Movers portfolio, holding a 4.6% average allocation over the year. This was the only sector that saw a steady allocation in both up and down markets and spent the highest percentage of weeks with long exposure in the portfolio. This represents an almost five-fold increase from 2023, when Financials held an average 0.8% allocation.

Information Technology was the second most favored sector of the year, with an average long allocation at 1.8%. The sector exhibited the most extreme up-market/down-market split in the portfolio, with a 6.8% allocation in up markets and a -7.3% allocation in down markets. Despite these swings, Tech maintained a significant allocation by being long for the majority of weeks in the portfolio. This marked a decline compared to 2023, when Tech was the portfolio’s largest allocation at 4.9%, similarly favoring up markets.

Industrials and Consumer Discretionary, both cyclical sectors, also displayed notable disparities between bull and bear markets. Both saw a roughly 2.5% long allocation in up markets but shifted to over 5% short allocations in down markets.

Health Care retained its position as the largest short sector in the portfolio at -2.4% on average, a continuation of its 2023 positioning. This short exposure was predominantly realized during up markets, as the defensive sector remained a popular short during periods of growth as it did in 2023.

Consumer Staples and Materials spent the least amount of time with a long allocation, each being long for only 36.5% of the weeks in 2024. Consumer Staples also stood out as the most frequently shorted sector, with a short allocation during 57.7% of the time.

We also examined the movement of stocks within various sectors based on their thematic exposures and identified top three thematic risk drivers for each sector using Omega Point recently introduced Thematic Package. Detailed analysis will be found in the Q1 2025 edition of our “Thematic Spotlight” report next week.

Style Summary

Back-and-forth investor sentiment was clear in 2024’s style factor exposures, with average exposures for many factors close to zero, but up-market and down-market allocations diverging significantly.

In 2024, U.S. investors adopted a more cautious approach compared to 2023, as evidenced by stronger negative exposures to Beta and Volatility factors in down-markets, and less positive exposures to these factors in up-markets.

While growth saw a positive allocation on average, the enthusiasm for growth names in down markets was notably reduced compared to the prior year. Value factors, on the other hand, exhibited a pronounced up-market/down-market split, particularly in Dividend Yield factors. This strong divergence was a departure from the behavior of Value factors in 2023, which generally saw much less favor for Dividend Yield in down-markets.

Interest Rate Beta was one of the only factors to see a positive average allocation in both up-market and down-market periods throughout the year. This marked a shift in investor behavior as cautious sentiment in 2023 shifted into a preference for rising rates sensitivity in 2024.

Within Crowding factors, investors showed a preference for popular hedge fund longs during up markets, but shorted them during down markets. This behavior differed from 2023, when crowded hedge fund names maintained a consistent positive exposure of 0.12 across both bull and bear markets. Short Interest saw negative allocation on average, primarily driven by its exposure in down markets. This represented a stark reversal from 2023, when Short Interest achieved its highest up-market exposure in the portfolio’s history at 0.25 and further demonstrates investors lessening appetite for risk even in positive economic conditions.

Overall, 2024 demonstrated a shift away from risk, with investors exercising more caution in both positive and negative economic conditions than they displayed in 2023.

Market Concentration

The Magnificent 7

The "Magnificent 7" stocks—Alphabet, Amazon, Meta, Microsoft, Nvidia, and Tesla—contributed to over half of the S&P 500's total returns in 2024, accounting for approximately 13% out of the index's 25% gains. The AI theme was a significant driver of this performance, with Nvidia alone responsible for more than 20% of the total returns of the S&P 500.

In terms of market representation, the "Magnificent 7" stocks have seen their share of the S&P 500 triple since 2016, rising from approximately 11% to a peak of around 33% by December 2024. This growth has also significantly increased their contribution to the index's overall risk. The risk contribution surged in Q1 2024 and remained elevated throughout the year, accounting for about 46% of the total risk by year-end. This indicates that almost half of the S&P 500's market volatility is now attributed to these seven stocks.

Effective Number of Stocks

The largest stocks in the market now account for a significant share of returns, market capitalization, and overall risk. However, their growing influence has also impacted broad-based indices, which were originally designed to reflect a diverse range of stocks. The "Effective Number of Stocks" metric below, calculated using the Herfindahl-Hirschman Index. , illustrates this shift. This measure represents the number of equally weighted stocks an index behaves like in practice.

The effective number of stocks in the U.S. market has decreased significantly since 2020, dropping by more than 50% across major indices. The Russell 3000 declined from 139 to 65 stocks, the Russell 1000 from 122 to 59, and the S&P 500 from 101 to 48. This indicates that these indices have become less diversified and are increasingly reliant on the performance of a few large stocks. However, this trend appeared to slow in the second half of 2024, suggesting a potential stabilization in market concentration.

Style Factor Returns Spotlight

Several risk factors deviated from their long-term trends in 2024, with Momentum, Exchange Rate Sensitivity, and Growth emerging as standout performers. Momentum, in particular, delivered exceptionally strong returns, marking its best performance in recent years. Conversely, ETF Flow experienced notably weak performance, reflecting a sharp decline compared to its historical trend.

Momentum delivered exceptional performance this year, achieving a 9.86% return — the highest yearly return since 2008. This marks a significant departure from the historical average of 0.84%. The strong performance was driven by sectors tied to Artificial Intelligence, which thrived in 2023 and continued to perform well in 2024. Interestingly, Financials did not participate in the 2024 momentum rally. We also saw that momentum continued to exhibit positive performance following the US presidential elections, despite uncertainty in the market around how markets will fare under the new administration.

Similarly, the Exchange Rates Sensitivity factor saw remarkable results, posting a 5.38% return, also the highest since 2008. This performance was fueled by heightened volatility in currency markets, stemming from a mix of geopolitical and economic factors. The return significantly outpaced the historical average of 0.86%, underscoring the impact of these market dynamics.

The Growth factor also performed exceptionally well, achieving a 3.42% return. This performance far exceeded the historical average of 0.20%, with Information Technology sector companies being the key drivers of this success.