Market Signals “Risk-On” with Economic Optimism

Last year, we introduced Extreme Movers, the latest tool in our arsenal to understand what is driving markets from week to week. In our January 8 edition, 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. In addition, we used that historical data to better categorize markets by how volatile and factor-driven they are. Going forward, we will use this framework to to give our readers a sense of the current climate that fundamental managers face each week.

The Extreme Movers portfolios are weekly-rebalanced, market-neutral portfolios that consist of the top decile of stocks from the Russell 1000 and 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 portfolios in the May 22, 2022, edition of Factor Spotlight.

Market Summary

US Market: 1/27/2023 - 2/2/2023

• US headline indices finished the week strong after a three-day losing streak. The Nasdaq topped the list at 5.98%. The S&P followed at 2.94% and the Dow at 0.31%
• The FED raised rates by the widely forecasted 25 bps, representing the smallest hike since March, 2022. The expectation, however, is for more rate hikes to come in the upcoming months.
• The job market added 517,000 jobs in January, exceeding analysts’ expectations. The news had a mixed reception as a booming labor market may have an adverse impact in inflation, and therefore, continued pressure on the FED.

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. Earlier this year, 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."

US Extreme Movers Volatility and Factor-Driven Speedometers

• The US Extreme Movers portfolio returned 19.9% this week, sneaking into the “Very Volatile” territory.
• 41.7% of the portfolio's performance was attributed to factors, which classifies it as an “Very Factor-Driven” week. This week's factor contribution lands in the 88th percentile of all weeks since January of 2007.
• Style factors led factor performance with Market Sensitivity and Momentum contributing a combined 80% of the style factor performance. Oil, Gas, and Consumable Fuels led industry factor performance.

International Extreme Movers Volatility and Factor-Driven Speedometers

• The International Extreme Movers portfolio returned 16.8% this week, landing at the middle of the “Volatile” category.
• International Markets saw a greater than usual impact from factors this week. At 29.8%, factor performance just crossed the “Neutral” threshold into “Factor-Driven” territory.

US Extreme Movers Portfolio Exposures

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 US Extreme Movers portfolio had strong overexposure to Information Technology, mostly driven by Software. However, the allocation was neutral for Semiconductors, and negative for Hardware.
• The short Energy sector allocation represented one of the lowest in the last 12 months, exclusively driven by Oil, Gas, & Consumable Fuels.
• Health Care’s short allocation was mostly driven by Pharma and Biotech, while Consumer Staples was driven by Beverages and Food Products.

• Virtually all style exposures increased in magnitude from last week to this week. Beta exposure reached its fourth highest levels in the past 12 months, and the highest since November as renewed economic optimism drove investors into high beta stocks.
• The tilts against value factors and towards growth grew stronger in 2023’s “growth risk-on” rally as all value factors landed in the bottom quintile on a trailing twelve month basis.
• Oil Beta and Interest Rate Beta exposures also reached their lowest levels since July amid a more optimistic inflation outlook and slowing rate hikes.
• Short Crowded names were squeezed across the board, with CVNA, OPEN, PTON, and LCID all increasing by at least 30% this week.

International Extreme Movers Portfolio Exposures

• Similar to its US counterpart, the International Extreme Movers portfolio saw heavy allocations in favor of Information Technology and against defensive sectors such as Consumer Staples, Health Care, and Utilities.
• The Information Technology allocation reached its highest levels in the last 12 months, driven by Electronic Equipment and Semiconductors. Most companies contributing to this exposure are based in China, Taiwan, and South Korea.
• Energy’s underexposure was driven by Oil, Gas, & Consumable Fuels while Utilities’ underexposure was driven by Gas Utilities, Electric Utilities, and Independent Power and Renewable Electricity Producers.

• The International Extreme Movers Portfolio saw a reversion in Beta and Volatility, as both changed in direction compared to last week’s exposures. Growth and Value factors remained generally neutral and did not see much deviation compared to last week.
• Both Long Crowded names and Short Crowded names hurt investors’ portfolios, as popular longs did not perform as expected, and popular shorts saw positive performance across the board.
• Oil Beta and Interest Rate Beta exposures declined this week, landing close to neutral territory.

Regards,
David