Increased Alpha Opportunity Amid Continued Risk-On / Risk-Off Sentiment

In the last issue of Factor Spotlight, we introduced the latest tool in our arsenal to understand what is driving markets from week to week. The Extreme Movers portfolio allows us to apply hindsight to the prior week's momentum to understand the following key questions better:

1. Was the preceding week an alpha-driven or factor-driven week?
2. What are the factor characteristics of the stocks that drove the market?

The Extreme Movers portfolio is a weekly-rebalanced, market-neutral portfolio that consists of the top 100 performing stocks from the Russell 1000 on the long side and the bottom 100 on the short side. You can find additional information on the construction of the Extreme Movers portfolio in the last edition of Factor Spotlight.

Moving forward, we will incorporate the most insightful takeaways across the Extreme Movers portfolio and Surprise Metric analyses into Factor Spotlight. We'll only include one or the other in some weeks, and in other weeks we may include both. For example, this week was heavily alpha-driven (as noted in more detail within the summary below), so we felt it was more relevant to focus on the Extreme Movers portfolio.

Please see below for this week’s Market Summary recap and Extreme Movers portfolio summary. Also, don’t hesitate to reach out if you’d like to understand more about the Extreme Movers portfolio!

US Market Summary and Extreme Movers Metrics

US Market: 05/27/22 - 06/02/22

• Markets showed a small glimmer of hope this week. All major US indices were trading positive for the week ending Thursday, closing out two weeks of overall positive return for the US. The Nasdaq showed a heavy rally, finishing Thursday’s session with a 5-day return of 4.83%. The S&P and Dow followed suit, with 5-day returns of 2.84% and 1.43%, respectively.
• The Federal Reserve is employing its quantitative tightening program as a second key tool in its fight against inflation. On Wednesday, the Fed began to run down the balance sheet, using a combination of selling debt holdings and allowing maturing treasuries to roll without plans for reinvestment.
• OPEC+ announced plans to increase oil output to help meet severe demand. The move is expected to help quell oil price woes, especially heading into the summer months.

Extreme Movers Portfolio Performance

By constructing a portfolio that is long the Top 100 movers and short the Bottom 100 movers in the Russell 1000, the portfolio's return will always be positive. That said, there are several areas we want to observe around weekly performance:

1. Is the weekly performance below or above the recent median weekly performance? Above the recent median means that the Extreme Movers portfolio had much higher dispersion than a typical week, most likely being driven by higher factor volatility.
2. Is the weekly alpha contribution below or above the recent median alpha contribution? Above the recent median demonstrates that the significant market moves were more alpha-driven than in a typical week. Below the median, the market moves were more factor-driven than in a typical week.

• Over the last two weeks, the Extreme Movers Portfolio has shown much more muted returns relative to the rest of May. The portfolio posted a 15.1% return, far below the week ending May 11th, which saw a 35.5% return.
• The last two weeks of total return also sit below the year-to-date median, pointing to lower return dispersion amid a relatively quieter market here in the US.
• From a factor decomposition perspective, style factors played much less of a role over the past couple of weeks than they had previously. Alpha contribution rose above the year-to-date median for the first time since early April, signifying a greater idiosyncratic opportunity in the market.

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.

• This past week, the most significant shifts in sector allocation resided in Consumer Discretionary, Health Care, Communication Services, and Information Technology. Consumer Discretionary, Information Technology, and Communication Services all saw substantial upward shifts, while Health Care saw massive downward pressure.
• The most significant move was in Consumer Discretionary, which had been the portfolio's biggest short position and is now its biggest long position, pointing to an impressive rebound.
• Consumer Staples, Utilities, Materials, and Financials also saw notable shifts. In contrast to their strong YTD average overweights, these sectors all moved to underweights in the portfolio this week.

• The style shifts, alongside the sector allocation changes, paint a more complete picture, particularly regarding beta and volatility.
• This past week, the Extreme Movers portfolio moved heavily into high beta and high residual volatility stocks. Alongside the move away from quality and value factors, there’s a hint of heightened risk tolerance in the market.
• The portfolio saw a strong swing towards positive interest rate beta on the macro side. This positive swing may represent renewed perception of the aggressive plans of the Fed to fight inflation.
• In terms of crowding, the portfolio shorted popular hedge fund long positions. It went long into popular hedge fund shorts, indicating that hedge funds were likely to see negative pressures in their portfolios this week.

Regards,
Alyx