Characteristics of the Recent Selloffs

Over the past couple of weeks, we've discussed the factor rotation we observed during the initial market selloff, and how you can create a defensive basket of ETFs to maximize exposure to the defensive factors (Value, Profitability) and minimize exposure to the cyclical factors (Volatility, Market Sensitivity).

Over the past month, we've seen two periods of market drawdown. For our purposes, we'll be looking at two date ranges: the first move down (9/26 - 10/10), and the second (10/17-10/24). While these moves may look similar in the broad market indices, a closer inspection in the key factors suggests that the underlying equity market behavior was different in each move.

In the initial selloff from 9/26-10/10, we saw a rotation out of high risk names into safer names:

 In the following selloff (10/17-10/25), the de-risking continued, but capital did not flow into cheaper, safer equity names:

In fact, the Value factor return for the entire period highlights a complete reversion in the second selloff.

This reversion could suggest that the composition of the Value factor had changed between the two periods. Applying a similar decomposition of the Value Factor Mimicking Portfolio (FMP) as we had done in Size suggests that with the exception of Software, the average industry weightings in Value didn't dramatically change.

We've conducted a similar analysis on Profitability and reached comparable conclusions — neither factor experienced a material change in its composition over the past month.

Without (a) the safety factors absorbing capital flows from the risky factors and (b) a material change in the individual factor compositions over the past month, we are left to conclude that the second selloff was largely a net outflow from the equity markets, rather than a rotation within the equity markets.

‍We'll continue to monitor the factor characteristics in the coming weeks to identify possible changes in the market structure. If you'd like to discuss FMPs, or would like to better understand how we measure the relationships between factors, please don't hesitate to reach out.

Regards,
Omer