Investors Scramble to Safety As Inflation Continues To Rage

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: 10/07/22 - 10/13/22

• There was a bit more dispersion in the major US indices this week. The Dow stayed in the green with a 0.4% return, while the S&P fell -2.0%. The Nasdaq was hit hardest through Thursday with a one-week return of -3.8%.
• September's CPI report showed headline inflation rise by 0.4% month-over-month and core inflation rise by 0.6%, both of which were higher than expectations. Stocks reacted negatively in Wednesday's trading as many investors now anticipate a 75 bp hike from the Fed in November.

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.

• Total return remained consistent week-over-week in the US Extreme Movers portfolio, sitting right around its year-to-date median of 17.6%.
• Alpha's performance was overshadowed by factors with a fairly even split between style and industry at 23% and 21%, respectively.
• An underexposure to beta and short allocations to Semiconductors and Software heavily influenced factor performance.

• The International Extreme movers portfolio also remained consistent with its prior week, coming in just shy of its year-to-date median at 17.5%
• While there was more alpha in the ex-US portfolio, style and country factors delivered the most significant systematic contributions.
• This week's factor drivers of the performance came from underexposure to beta and a short allocation to China.

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.

• The US portfolio had a 56% short allocation to Information Technology which marks the most significant single-sector allocation since inception. Software, Semiconductors, and IT Services led the positioning.
• Long positions in consumer sectors, namely Food Products, counterbalanced the heavy tech short as continued inflation pushed investors back into defensive stocks.
• Oil, Gas, & Consumable Fuels drove Energy's long allocation on the back of the OPEC+ oil production cut announcement and continued inflation fears.

• The US portfolio turned away from high beta, growth stocks as these are prone to be most adversely impacted by more aggressive rate hikes from the Federal Reserve.
• Alternatively, the portfolio moved to value and profitability factors in a defensive flight to quality, gearing up for prolonged economic uncertainty.
• The portfolio maintained its position toward stocks with positive sensitivities to Interest Rate Beta and Oil Beta, given the abundance of economic news in the market this week.

• Distribution across the International Extreme Movers portfolio was much more even than the US version due to only an 8% short allocation to Information Technology.
• Consumer Discretionary was the largest underweight at 13%, driven by Hotels, Restaurants, & Leisure, a likely defensive positioning against inflationary pressures.

• The International Extreme Movers portfolio also fled from high beta, growth-oriented stocks into value this week but remained relatively neutral and, even slightly underexposed, to profitability factors.
• From a macro perspective, the portfolio was positively exposed to rates as continued inflation will likely mean hawkish central bank policy but was much less sensitive to Oil Beta than the US version.
• However, the portfolio had positive sensitivity to HF Crowding and Short Interest factors, which indicates that hedge fund managers likely faced less crowding pressure this week.

Regards,
Kevin