Macro Matters, Even for Fundamentalists

Fundamental and macro-oriented strategies have traditionally been separate and distinct styles of investing. Fundamental managers take a bottoms-up approach to identify companies that they believe are poised for future success or failure while macro managers employ more of a top-down view to isolate broader economic trends and then select those stocks which stand to be most impacted.

Fundamental managers have been embracing systematic factor analysis that helps explain their portfolios’ historical and predicted movements using traditional, familiar factors such as market cap, growth, value, liquidity, momentum, and others. However, there is no reason why we can’t also use macro insights to our advantage especially since more and more evidence is suggesting that macro and fundamental research can work powerfully in tandem.

The economic and financial world has changed dramatically, culminating in the recent move towards direct fiscal stimuli. Equity markets are increasingly being driven by macroeconomic factors. Inflation, interest rates, GDP, corporate spreads, commodity prices, etc. have a material influence on equity prices that are extremely important to quantify. Over the past twelve months alone, we have witnessed countless examples of equity markets’ dependency on fiscal and monetary policy, economic growth, and commodities such as oil and metals._‍

Quantifying the Macro Impact

To dig into the impact of macro factors, we will start by leveraging the Axioma Worldwide Macroprojection 4 Medium Horizon model. The model uses the Axioma Worldwide Fundamental risk model as a base and projects its fundamental factors onto macro factors such as inflation, commodities, interest rates, corporate spreads, and more to explain the exposures, risk, and performance of stocks through a macroeconomic lens.

As a starting, point, we collected the contribution to forecasted volatility from macro factors for each SPDR Select Sector ETF below. Though the magnitudes vary, we see that a significant portion of risk can be explained through this method with 6 of the 11 sectors above 40% contribution.

Next, to better understand the trends in macro versus sector contribution, we calculated the five-year average contribution to forecasted volatility for each sector ETF relative to the SPY and compared that to its current level. Macro explanatory power has maintained a significant stake in many sectors but there are a few notable segments of the market worth noting. Consumer Discretionary, Health Care, and Consumer Staples are currently more heavily influenced by macro factors than they have been historically. For fundamental managers, this is a key insight and a call to action to delineate the driving forces at play beyond just the fundamental characteristics of these stocks.

Macro Influence in Energy

Energy, as expected, is a sector that has seen a great deal of macro factor influence. Interestingly, when we decompose the contribution to absolute risk of the XLE ETF, we see that the leading factor changed hands in March of 2020 during the COVID crash. The Oil factor decreased from a peak of 40.6% contribution down to a trough of 0.2% while Inflation increased from a trough of 7.6% to a peak of 42.1%. Though the two factors have begun to slowly revert back, Inflation remains the highest macro contributor to risk.

Observing the factor exposures, we find that while Oil exposure subsided, Inflation exposure rose. Although the magnitude of Inflation exposure is much higher, Oil is a much more volatile factor which is why, in terms of contribution, both play pivotal roles in the risk of the Energy sector.

Shifting the focus to performance, the changes in exposure, combined with the fact that the Inflation factor rose while Oil fell, resulted in significant headwinds and tailwinds for the sector as a whole. XLE has seen a performance contribution of 22.5% from Inflation and -26.9% from Oil since the beginning of 2020.

How to Marry Macro and Fundamental

There are a number of ways that fundamental managers can incorporate macro research into their existing workflows. The idea is not to be disruptive, but supportive. Macro data can be informative in the way that it provides context around broader forces of concern in the market. It can also produce an additional lens for managers to understand the drivers of risk and performance in their portfolios and how those drivers relate to fundamental factors as well.

In the coming weeks, we will be exploring the application of macro data in a fundamental workflow in a way that can better inform portfolio analysis, construction, and risk mitigation. If you are interested in engaging in these topics in more detail, please don’t hesitate to reach out to us!

US & Global Market Summary

US Market: 04/19/21 - 04/23/21

• Stock rallied at the end of the week capping a volatile week for the U.S. stock market, during which major indexes swung widely in both directions.
• Markets plunged on Thursday after President Joe Biden announced that he would seek an increase in the tax on capital gains to 39.6% from 20% for those Americans earning more than $1 million.
• The Labor Department announced weekly jobless claims hit the lowest level since the pandemic began.
• Data firm IHS Markit said its U.S. services index jumped in March, signaling the fastest expansion in service-sector activity since data collection for the series began in 2009.
• Manufacturers signaled a steep rise in output in April, even as many firms said production capacity was impeded due to issues sourcing raw materials.
• Though Covid-19 vaccines have rolled out faster than expected in the U.S., the virus is still surging elsewhere around the globe. India recorded the world’s biggest ever single-day jump of new infections this past week.
• A strong sale of 30-year Treasury bonds on Tuesday helped to instill confidence in the market since there had been concerns leading up to it over whether investor demand could absorb a large wave of newly issued debt.

Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)

• For the 4th consecutive week Growth and Value sit on opposite sides of the US factor leaderboard as rotation continues, but a fall in absolute delta may suggest changing skies ahead.
• Momentum gains for the 4th week in a row and crosses over the historical mean.
• Volatility ekes out a slight gain for the 3rd straight week, but still remains deep in negative terrain.
• Profitability and Size took a breather and slid after 5 consecutive positive weeks climbing in tandem.
• Market Sensitivity and Earnings Yield fell again with both moving further into negative territory.
• US Total Risk (using the Russell 3000 as proxy) declined by 58 basis points.

‍Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• Identical to the US, the global leaderboard bookends highlight the month-long rotation out of Value and into Growth.
• Momentum continues to surge and moves further into positive terrain.
• After weeks of middling movement, Exchange Rate Sensitivity shows signs of direction and finishes in the leaderboard’s top 3.
• After falling for 4 straight weeks, Volatility inched out a basis point gain.
• Market Sensitivity saw a decline for the 5th week in a row and moves into oversold territory.
• Earnings Yield fell again and sits much further away from it Extremely Overbought status seen just 3 weeks prior.
• Global Risk (using the ACWI as proxy) decreased by 67bps.

Regards,
Kevin