Macro Drivers Tumble as Market Starts to Rally

Over the past several weeks, 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.

See below for this week's Market Summary recap and Extreme Movers portfolio summaries. In addition, due to a highly unusual realignment that we're seeing in the markets, this week, we've applied our Surprise Metric to help better understand the market's follow-on reaction to the CPI data released on June 10.

US Market Summary and Extreme Movers Metrics

US Market: 07/01/22 - 07/07/22

• All three major US indices posted positive returns over the one week ending July 7. The Nasdaq led the way at 5.4%, with the Dow and S&P 500 trailing behind at 2.0% and 3.1%, respectively.
• Friday’s jobs report showed 372,000 jobs added in June and no movement in unemployment which may have eased some fears around the onset of a recession.
• Investors are gearing up for an eventful week as earnings season ramps, combined with a heavily-anticipated consumer inflation release due on Wednesday.

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.

• After a sharp decline the week of June 29, the US Extreme Movers portfolio rebounded but still fell below its year-to-date median with a return of 15.9%
• While the performance rose, alpha took a back seat to style and industry factors. Factors, in aggregate, contributed more than 53% of the portfolio’s return. That ranks third in terms of the most factor-dominated weeks of the year.

• The International Extreme Movers Portfolio has been more consistent in recent weeks but saw an uptick in performance this week, rising above its year-to-date median.
• Industry factors continue to be the leaders for the international portfolio but style factors, which have been quieter of late, made somewhat of a comeback, contributing 10% of the overall return this week.

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.

• Health Care has come far down from its 43% allocation a few weeks back but remains the most significant long position in the US portfolio.
• Energy, on the other hand, was significantly underweight this week. Energy's portfolio composition has been trending downward over the past few weeks as its component stocks have slipped off their oil and gas-priced highs.

• There were another couple of back-and-forth weeks in style factor exposures as investors trade off between beta and volatility.
• Growth factors returned to positive territory this week while the US portfolio leaned away from value-oriented, earnings-yielding stocks.
• As we've seen over the past month, the equity markets have not followed the rising interest rate trend as the Interest Rate Beta factor became the largest underexposure this week.

• The International Extreme Movers portfolio mirrored the US version in its most significant sector overweight and underweight. The international portfolio even increased its long exposure to Health Care to 26% net.
• As we saw in our previous edition of Factor Spotlight, the most considerable directional disparity was in Information Technology. The International portfolio held a 9% net short position in tech relative to a 10% net long position in the US version.

• The international portfolio actually pushed away from high beta names but maintained a positive exposure to stocks with higher residual volatility.
• Similar to the US portfolio, the international portfolio was significantly short Earnings Yield this week but was slightly more neutral to growth factors.
• Interest Rate Beta was, yet again, another point of consistency between the two portfolios as investors sell off stocks that typically benefit from rising rates.

Macro and Style Surprise

As noted earlier, we are leveraging our surprise metric methodology to understand further the market movements since the publication of the CPI data in early June. We applied the surprise metric on various risk model factor returns and volatility from June 10 through July 6. Interestingly, but likely not surprisingly, we see that macro continues to drive market movements. This week, we see that some of the most extreme surprises came from the macro factors within the Axioma Worldwide Macroprojection risk model.

• Macro factors across the board saw substantial negative surprise. This negative surprise translated to downward price pressure on global risky corporate and long-duration securities and for inflation- and commodity-sensitive assets.
• Strong negative surprise on the developed ex-US and US Value factors indicate a slowdown in value rotation. This slowdown is fueled further by positive surprise from the global and US Growth factors.
• Despite the recent market rally, beta continues to see-saw, which led to little representation in the top surprise factors. However, developed markets showed a sell-off in high beta assets.

Regards,
Kevin