Markets Slip but Alpha Shows Big Rebound

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. From now on, we will use this framework 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: 2/3/2023 - 2/9/2023

• US headline indices snapped a long-awaited winning streak this week as the Nasdaq fell 3.4%. The S&P 500 followed at 2.4%, while the Dow was down 1.0%.
• Alphabet shares were down almost 12% from Thursday to Friday after an unimpressive debut of its competitive answer to OpenAI.
• Russia announced plans to cut oil production by 500,000 barrels per day, pushing prices higher on Friday before tapering off before the weekend.

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 volatility spread above 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 16.6% this week, which falls in the second quintile of historical returns, classifying it as "Volatile."
• 89% of the portfolio’s return was attributable to alpha which places this week in the “Very Alpha-Driven” category. This grade marks the highest level of alpha contribution since November and is only the fifth “Very Alpha-Driven” week in the last 12 months.
• A higher level of volatility coinciding with an “Alpha-Driven” market provides fundamental investors with a favorable stock-picking market, given that stock prices are moving considerably but are being driven by stock-specific forces rather than systematic market forces.

International Extreme Movers Volatility and Factor-Driven Speedometers

• The International Extreme Movers portfolio was categorically similar to the US this week. The portfolio returned 16%, and 81% of the return was driven by alpha, making it both "Volatile" and "Very Alpha-Driven."
• This level represents the first "Very Alpha-Driven" week in the ex-US market since December 2021.

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 columns that represent where the exposure ranks on both a trailing twelve-month (“TTM”) percentile (“Ptile”) basis and an inception-to-date (“ITD”) percentile basis. The inception date for these portfolios is January 1st, 2007.

• Sectors were relatively well distributed across the US Extreme Movers portfolio this week. Information Technology and Financials were the most significant long allocations, while Consumer Discretionary and Materials were the largest short allocations. Materials' sell-off was in the bottom 5% of all weeks since 2007.
• Software & Services led the tech rally by way of alpha. 96% of the return contributed from Software & Services stocks was idiosyncratic.
• The short allocation in Consumer Discretionary was more market-driven as Consumer Durables & Apparel experienced broader sell-offs this week.

• Coming off of a “Very Factor-Driven” week where style factor exposures reached near-record levels across the board, the portfolio showed its most style-neutral positioning in quite some time.
• The US portfolio leaned away from residual volatility factors, which usually point to investors' fear and a "risk-off" posture.
• Earnings Quality was the biggest overexposure as macroeconomic headlines made way for corporate earnings to return to the limelight.

International Extreme Movers Portfolio Exposures

• Information Technology, Materials, and Consumer Discretionary sectors told a similar story in the International portfolio as global markets largely aligned this week.
• Software & Services and Technology Hardware & Equipment led the long allocation to tech. Nearly half of that Information Technology position came from Taiwanese stocks after China publicly promoted a more peaceful future relationship between the two nations.
• Canadian Metals & Mining stocks drove the short allocation in the Materials sector following news that the Canadian government will not allow seafloor mining.

• Like the US portfolio, Residual Volatility was the style the International portfolio disliked most this week. The exposures in the Axioma Worldwide and Barra Global models were among the lowest recorded since the portfolio’s inception.
• Though the International portfolio placed a premium on quality factors, it leaned more heavily toward Profitability than Earnings Quality.
• Oil Beta was a significant underexposure this week, driven mainly by long allocations to Diversified Financials and Banks.

Regards,
Kevin