January Providing (Factor-Driven) Relief

Last year, we introduced Extreme Movers, the latest tool in our arsenal to understand what is driving markets from week to week. Last week, 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. We used that historical data to better categorize markets by how volatile and factor-driven they are. This week, we will focus on the US Extreme Movers portfolio through the lens of that contextual analysis to give our readers a sense of the current climate fundamental managers are facing.

The US Extreme Movers portfolio is a weekly-rebalanced, market-neutral portfolio that consists of the top decile of stocks from the Russell 1000 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, 2022, edition of Factor Spotlight.

Market Summary

US Market: 1/6/2023 - 1/12/2023

• The US market continued its strong start to the year. The Nasdaq led the headline industries with a 6.8% return through the five trading days ending January 12th, while the S&P 500 and Dow Jones Industrial Average followed at 4.6% and 3.8%, respectively.
• The publication of the December Fed minutes revealed a continued commitment to fighting inflation through rate hikes for the foreseeable future, which was an expected outcome for the market.
• However, a decline in the Consumer Price Index (CPI) from 7.1% to 6.5% in December reinvigorated investors, which marked a rare positive indication of slowing inflation.

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. Last week, 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."

• This week, the US Extreme Movers portfolio returned 20.5%, which falls in the top quintile of historical returns and is thus categorized as a “Very Volatile” period.
• This week marks the 25th “Very Volatile” week in the last twelve months as the market continues its record streak of volatility not seen since 2008.

• Factors, in aggregate, accounted for 35.4% of this week’s performance, which also lands in the top quintile, designating this week a “Very Factor-Driven” period.
• Weeks both “Very Volatile” and “Very Factor-Driven” present a challenging environment for fundamental investors. During these periods, stock prices are moving significantly, but those movements are not fueled by nuanced, stock-specific catalysts but by common, systematic market forces.

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 included a third column that represents where the exposure ranks in the trailing twelve-month (“TTM”) percentile (“Ptile”).

• The Consumer Discretionary sector was the most significant long allocation in the US Extreme Movers portfolio for the second straight week. The exposure was mainly driven by a 10% long position in Retailing.
• A 10% short allocation to Biotech and a 7% short allocation to Health Care Equipment & Supplies allowed Health Care to take over Energy as the most significant sector underweight in the portfolio this week.
• Although relatively neutral this week at a net 3% long, Information Technology showed an interesting split. Semiconductors accounted for an 11% long allocation, while Software & Services balanced it with a 12% short allocation.

• Beta & Volatility factors continued to lead the style characteristics this week as cautious economic optimism guided investors into riskier stocks.
• Though Growth factor exposures were only marginally positive, the portfolio tilted away from Value and Quality factors through the long allocation to Consumer Discretionary.
• The Short Interest factor exposure fell in the 96th percentile of the portfolio’s trailing twelve months. As the market took a positive swing at the start of the year, popular short positions in previously beaten-down industries like Retailing, Capital Goods, and Automobiles & Components have rallied.

Regards,
Kevin