Navigating the Tails of Growth & Value

As we continue into earnings season, the markets are throwing curveballs as investors navigate earnings surprises, the fall of tech stocks, and the backdrop of looming Fed action to unwind the US quantitative easing program to combat record inflation. As if that wasn’t enough, the reprise of the growth vs. value rotation is in full swing.

January has seen a growth sell-off and value rally unlike many points in recent history. For example, the Growth & Value factors from the Axioma US 4 Medium Horizon (“AXUS”) risk model returned -2.15% and 3.32%, respectively, from January 3 to January 18.

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These returns represent a significant tail event. A plot of the distribution of the rolling 10-day factor returns since 2007 shows that the January 3 to January 18 Growth return is the most significant 10-day drawdown for the factor. Furthermore, almost all 10-day returns since the beginning of the year are in the bottom 25%.The Value factor has a similar story, with the January 3 to January 18 return being the 4th largest in the factor’s history and all recent returns in the top quartile.

Based on the data above, 2022’s Growth vs. Value rotation has equated to a ~5 standard deviation occurrence for both factors.

The correlation of Growth vs. Value is at historic magnitudes, adding even more fuel to the fire. We wrote about this trend in November 2021, when the rotation first started in earnest. The predicted correlation of these two factors has only continued on its increasingly negative trend since that time.

The current correlation of Growth vs. Value is -0.69, which is an extremely strong negative relationship. In fact, it is currently the strongest relationship across style factor pairs in the AXUS risk model.

Defensive Positioning

The forward-looking risk of Growth & Value, as measured by the AXUS predicted volatility, has been at elevated levels for some time. Though Value was showing signs of declining, that trend has reversed course, and growth is now experiencing the highest predicted volatility that the factor has seen.

Investors may want to position portfolios to better weather the storm due to the current market environment and the likelihood of continued multi-standard deviation systematic events.

Using the expected volatility of the Growth & Value factors, we can create guidelines for positioning a portfolio relative to these factors to avoid large magnitude losses if tumultuous returns continue.

The current predicted volatility of the factors is 3.36% and 4.13%, respectively. So what does this mean? If these estimates are realized, the two factors will move by 3.36% and 4.13% annually, translating to ~0.67% and ~0.82% on a 10-day basis. All else equal, portfolios could experience a drag of over 50 bps from either of these factors if the Growth exposure is at least 0.75 (-50 bps / -0.67% = 0.57) or the Value exposure is at least -0.61 (-50 bps / 0.82% = -0.61).

In practice, a Growth exposure of 0.75 or a Value exposure of -0.61 would be very significant for a fundamental investor portfolio. However, as we’ve seen over the last couple of weeks, we’re operating in a tail-event market, so we should expect these factors to be swinging more in the 2 to 5 standard deviation range. Updating our calculation shows that if there’s even a two standard deviation event, it will only take exposures of 0.37 and -0.30 respectively to experience 50 bps of drag over ten days from Growth or Value. These exposures tighten to 0.15 and -0.12 if we assume returns are in the five standard deviation range.

To put this into context, below are the Growth and Value exposures for several major market segments, as well as hedge fund proxy portfolios provided by Wolfe Research.

As we can see, several of the pockets of the market, especially the tech- and consumer-focused segments, possess significant susceptibilities that many fundamental investor portfolios are also likely facing at the moment.

In the coming weeks, we’ll continue to help investors navigate the rocky environment and present solutions on how to find names, either within the portfolio or within a coverage universe, to improve positioning and mitigate future losses. As always, please feel free to reach out to us if you want to learn more.

‍US & Global Market Summary

US Market: 01/18/22 - 01/21/22

• The S&P 500 slid 5.7%, and the Dow and Nasdaq Composite fell 4.6% and 7.6%, respectively, all three indices’ worst weeks since 2020. Stocks fell as investors worried about corporate profits, rising interest rates, and geopolitical tensions.
• Netflix dropped 24% after it told investors it expected to add just 2.5 million subscribers during the first quarter of 2022, well below forecasts for 5.7 million.
• The rate on the 2-year Treasury note hit its highest level since March 2020, while the mid-to-long end has remained restrained as investors grapple with how aggressive the Fed will be in response to surging inflation.
• Bitcoin tumbled in an extended selloff for cryptocurrencies, briefly falling below $38,000 to its lowest level in more than five months.
• A report that Washington is allowing some Baltic states to send U.S.-made weapons to Ukraine fueled concerns about a standoff with Russia.
• One of the few bright spots for the markets this week was the tenth-straight monthly gain for the Leading Economic Index for the month of December.

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

• Value secured the top spot for the third straight week and now hovers in extremely overbought territory at +2.28 SD above the mean.
• Profitability moved upward for a second consecutive week following its recent slump.
• Earnings Yield slid slightly from its steady, multi-month climb to land at +1.84 SD above the mean but still within reach of extremely overbought status.
• Medium-Term Momentum fell once again and is approaching extremely oversold terrain.
• Growth continued to show intense weakness and finished at the bottom of the U.S. leaderboard for the second week in a row.
• U.S. Total Risk rose by 0.51% during this shortened holiday week.

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

• Exchange Rate Sensitivity put its now month-long rally into a higher gear to cross into positive terrain and easily take this week’s top spot.
• Market Sensitivity put its oversold status only 3-weeks prior further into the rearview to land at +0.45 SD above the mean.
• Value failed to score a three-peat atop the global leaderboard but maintained its march upward as it now sits deeper in extremely overbought terrain.
• Profitability let off some steam from its recent downward spiral but still fell for the sixth consecutive week.
• Size continues to show weakness as it approaches oversold status.
• Growth slid once again to cross into oversold terrain and finish the week at the bottom of the global leaderboard.
• Global Total Risk jumped a whopping 1.28% this week.

Regards,
Alyx