Investors Pile Into Financials Amid Indefinite Inflation Fight

Over the past several months, we've introduced Extreme Movers, the latest tool in our arsenal to understand what is driving markets from week to week. We also debuted an international version of the Extreme Movers portfolio to help investors compare fluctuating alpha opportunities and factor-driven dynamics between the US and the world. The Extreme Movers portfolios allow 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 portfolios are weekly-rebalanced, market-neutral portfolios that consist of the top decile of stocks from the Russell 1000 and the 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 portfolio in the May 22 edition of Factor Spotlight.

‍US Market Summary and Extreme Movers Metrics

US Market: 10/28/2022 - 11/03/2022

• It was a tough week for the US stock market, led by the Nasdaq, which was down -4.17% over the five trading days ending October 27. The S&P 500 and Dow followed behind at -2.3% and -0.1%, respectively.
• The biggest market driver was the Fed's decision to approve a fourth consecutive 75 basis point hike in interest rates. While it hinted at the potential of slowing rate hikes, there was no commitment to putting the brakes on anytime soon, which sent stocks plunging in Wednesday's trading session.
• The October Jobs report showed a higher-than-expected number of jobs added last month (261,000), while unemployment rose from 3.5% to 3.7%.

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, 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 portfolios had much higher dispersion than a typical week, most likely 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.

• The US Extreme Movers portfolio posted its highest return since the week ending August 3rd at 22.2%, well above its year-to-date median return of 17.6%.
• Alpha notched its fourth consecutive week of increased contribution, accounting for 78% of the portfolio's return.
• The factor footprint was evenly distributed between style and industry this week. Underexposures to beta and volatility accounted for nearly all the style movement, while an overweight to Insurance and an underweight to Software led the charge on the industry front.

• The International Extreme Movers Portfolio’s return remained similar to last week, still strongly outperforming its year-to-date median at 23.2%.
• Unlike the US portfolio, style and industry factors were quiet this week. Short allocations in Real Estate Management & Development and Metals & Mining accounted for much of the industry contribution.
• A long allocation in Brazil led the country factor contribution following this week's presidential election results and building confidence in a peaceful transition of power.

Extreme Movers Portfolio Exposure

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 adjusted the third column from YTD Average to YTD Ptile (“percentile”). With >200 trading days into the year, we’ll highlight any exposures that are in the top 10 trading days (95%+) or any exposures in the bottom 10 days (<5%).

• Financials were again the big story this week as the sector went from the largest short allocation to the most prominent long allocation this week, a move only eclipsed by four other days this year. Strong returns from Insurance and Capital Markets drove most of the surge.
• Industrials also highlighted a top-10 YTD move, rebounding from a sizeable short allocation last week.
• Health Care was somewhat neutral this week, but the industries thereunder were mixed. Biotech represented a 5% long allocation, while Life Science Tools & Services counterbalanced with a 5% short allocation.
• Software and IT Services caught the worst of it as investors fled from high-beta stocks. As a whole, Information Technology represented the largest short allocation at -24%.

• The week-over-week reversal over the risk-on, risk-off trade continued as the market shied away from risky, high-growth stocks and moved back into value-oriented quality stocks.
• With the Fed news, the portfolio positioned itself in line with rising rates by going long Financials and short Information Technology which drove a significantly positive exposure to Wolfe's Interest Rate Beta factor.
• Popular hedge fund stocks were under pressure this week as the US portfolio was short popular hedge fund long names and stocks that tend to be inversely correlated to popular hedge fund shorts.

• The most glaring difference between the US and international Extreme Movers portfolios was that the international portfolio took far less severe sector bets this week.
• Consumer sectors were in favor internationally. Internet & Direct Marketing Retail and Hotels, Restaurants & Leisure led the way, accounting for a combined 7% long allocation.
• Metals & Mining and Chemicals accounted for much of the short allocation to the Materials sector this week.

• The typical risk aversion indicators were mixed in the international portfolio this week. Though the portfolio was exposed to residual volatility, it was split on growth and value factors due to short allocations to Industrials and Real Estate.
• With continued rate hikes to combat inflation, the portfolio positioned itself accordingly, driven chiefly through the short allocation to Industrials and a long allocation to Consumer Discretionary stocks.
• Though directionally, Short Interest exposure was similar to that of the US portfolio, the international portfolio fell much more in line with the hedge fund community. The portfolio was long stocks inversely correlated to popular hedge fund shorts, pointing to some alignment with the international investment market.

Regards,
Kevin