Earnings Lead Market into Alpha- Driven Territory

For those who may have missed our news last week, I’d like to remind our readers that Omega Point recently launched its new website. For more details, I encourage you to check out our announcement in last week’s issue, which includes links to several sections of the new website we expect to be of particular interest to our readers.

One of our primary goals when building the new website was to pack it with practical, hands-on content that makes it easy for investors to learn how to understand their portfolios better and turn this knowledge into specific action. In that spirit, and starting this week, we’ll highlight particular examples on the new website that we hope you find especially relevant in the current market environment.

Today, we’ll lay some foundations, starting with a risk management use case that is top-of-mind for many portfolio managers and risk officers: how to reveal hidden drivers of risk and performance? Through a short video, screenshots, and three simple steps, we illustrate how to use Omega Point to identify style, sector, macro, and other factors impacting a portfolio’s risk and performance. We hope you find it helpful, and if you’d like to learn more, feel free to schedule a time to speak to us.

Last year, we introduced Extreme Movers, the latest tool in our arsenal to understand what is driving markets from week to week. In our January 8 edition, we analyzed the historical behavior of the US Extreme Movers portfolio to better contextualize recent markets in light of how they stack up against periods dating back to 2007. In addition, we used that historical data to better categorize markets by how volatile and factor-driven they are. This week, we will expand that contextual analysis to both the US and International Extreme Movers portfolios to give our readers a sense of the current climate that fundamental managers face.

The Extreme Movers portfolios are weekly-rebalanced, market-neutral portfolios that consist of the top decile of stocks from the Russell 1000 and MSCI ACWI ex-US, respectively, based on performance on the long side and the bottom decile on the short side. You can find additional information on the construction of the Extreme Movers portfolios in the May 22, 2022, edition of Factor Spotlight.

‍Market Summary

US Market: 1/20/2023 - 1/27/2023

• The US markets rebounded this week after last week's headwinds. The Nasdaq index had a strong performance, increasing by 6.08%. The Dow and S&P 500 also saw positive gains, with increases of 2.74% and 4.14%, respectively.
• The ongoing layoffs remain a significant concern for the economy. However, the recent jobless claims report showed a surprising decrease to its lowest point in over eight months. Investor sentiment remains uncertain due to the fluctuation of market performance during the current corporate earnings season.
• The housing market continued experiencing a decline in activity due to the impact of elevated mortgage rates on the purchase and sale of real estate properties.

Extreme Movers Portfolio Performance

Please note that the portfolio's return will always be positive by constructing a portfolio that is long the top movers and short the bottom movers in an index. That said, both the total return and decomposition of that return provide valuable insight into the conditions of the market. Earlier this year, we introduced a new framework to categorize weeks by how volatile and factor-driven they are based on the Extreme Movers portfolios. We leveraged that framework below to provide context around how this most recent week compares to historical markets back to 2007. What we want to observe is:

1. How volatile was this week? Because the Extreme Movers portfolios invest in the best and short the worst performers of the week, the total return of the portfolios points to the volatility spread available in the market. A large return suggests a wide dispersion of stock returns, while a smaller one suggests a light dispersion and calmer markets. We will categorize each week on a scale of "Very Calm" to "Very Volatile."
2. Was the market alpha-driven or factor-driven? By decomposing the total return into its underlying components, we can determine whether the aforementioned volatility spread provided fundamental investors with opportunities for alpha or factor noise, making alpha harder to come by. We will categorize each week on a scale of "Very Alpha-Driven" to "Very Factor-Driven."

US Extreme Movers Volatility and Factor-Driven Speedometers

• The US Extreme Movers portfolio returned 13.7% this week, falling into the upper end of our "Neutral" category.
• 19.0% of the portfolio's performance was attributed to factors, which classifies it as an “Alpha-Driven” week.

International Extreme Movers Volatility and Factor-Driven Speedometers

• The International Extreme Movers portfolio showed Neutral volatility and landed at a "Calm" performance level this week compared to its historical standards.
• This week's level of volatility was among the lowest in recent history, with only 25% of weeks over the past year classified as "Calm."
• The stability of this week presents a favorable opportunity for fundamental investors to identify profitable investments.

US Extreme Movers Portfolio Exposures

Looking at the Extreme Movers from an exposure lens helps us decompose the individual styles and sectors associated with the portfolio's factor-driven performance and better understand broader patterns such as risk-on / risk-off or sector rotation. To provide a relative perspective on the size of the exposures, we’ve included a third column that represents where the exposure ranks in the trailing twelve-month (“TTM”) percentile (“Ptile”).

• The US Extreme Movers portfolio saw meaningful exposures in Communication Services, Financials, and Information Technology. In particular, Communication Services’ 13% exposure, driven by Warner Bros, Paramount, and Netflix, was in the 97th percentile.
• Healthcare had one of its biggest underexposures in the last year, at -15% allocation representing the 12th percentile over the past year.
• Financials represented 13% of the portfolio, driven chiefly by Banks and Consumer Finance.
• Utilities slightly recovered from last week's extreme underweight in the portfolio but remained at the 13th percentile over the past twelve months.

• Style factors decreased across the board, with exposures to all factors landing close to the 50th percentile over the past 12 months. This level is consistent with this week's reading of "Neutral" performance and "Alpha-Driven" volatility.
• Both Value and Growth factors came closer to neutral, reversing the trend seen last week that favored growth over value. Additionally, Long Crowded names continued to positively impact hedge fund portfolios, while Short Crowded names also contributed positively, which was not the case last week.

International Extreme Movers Portfolio Exposures

• Consumer Discretionary drove international Extreme Movers overweight exposures at 8%, representing the 80th percentile TTM.
• The portfolio also exhibited strong representation in the Information Technology and Communication Services sectors, with Semiconductors leading the way in Information Technology and Entertainment leading in Communication Services.
• The Health Care sector led the underweights at -10% allocation, primarily driven by Pharmaceuticals, but Biotechnology, Healthcare Providers and Services, and Healthcare Equipment also contributed to this short allocation.

• The portfolio's Residual Volatility and Volatility exposures were at or above the 70th percentile TTM. The portfolio's overweight position in Consumer Discretionary and Information Technology and the underweight position in Healthcare drove both exposures.
• Long Crowded names and Short Crowded Names remained relatively neutral and close to the TTM mean. These levels are consistent with the calm performance and neutral volatility that the International Extreme Movers portfolio experienced this week.

Regards,
David

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