Rapid Recent Decline in Global Risk

We hope you've been enjoying the holiday weekend. Today, we'll be examining Total Risk in the global market (using the ACWI as a proxy) to see how it has trended over the past 12 months. Similar to the exercise we ran on the US market last week, we'll seek to further our understanding of the recent market recovery through a global risk lens, and then compare it to the recovery of early 2016.

First, let's start with a review of the past week's market and factor action:

‍US Market

The market ended essentially flat in a holiday-shortened week, ahead of next week's busy earnings calendar (35% of the S&P 500 will report). While the major indices hover near record levels, it's noteworthy that trading volumes have been suppressed — the rolling 10-day average of total composite volumes are at their their lowest since 9/12/18. If the average volume for April persists, it would be the most illiquid April since 2013, according to Dow Jones Market Data.

News also came out on Friday that US homebuilding fell to a two-year low in March, providing a counterpoint to some of the more sanguine data that we've seen recently in retail, trade, inventory, and construction spending.

Here's an update on how some key factors have changed in the US model over the past week, using our normalized return indicator:

• The massive rally in Profitability saw no brakes, and now sits at +0.7 standard deviations above the historical mean after bottoming at -2 SD exactly a month ago on 3/19. Earnings Yield continued to bounce off a -1.7 SD low (3/29) and is now firmly in neutral territory. The performance of these two factors suggests investors have been flocking to high quality names.
• Growth also continued its gradual recovery from a recent bottom of -1.11 SD below the mean on 4/5.
• The rate that Volatility and Market Sensitivity have been falling started to slow, as they continued to sell off a normalized basis but not as rapidly as we'd seen over the past couple months.
• Medium-Term Momentum continued to fall away from Overbought levels, and now sits at a neutral +0.68 SD above the mean.

Worldwide Risk

‍In last week's Factor Spotlight, we looked at Total Risk in the US over the past 12 months and determined that while Total Risk has fallen over the past few months, it remains elevated and hasn't dropped as quickly as it did during the recovery of early 2016. This week, we'll use the worldwide model to examine Total Risk in the MSCI All Country World Index (ACWI), which captures large and mid-cap representation across developed and emerging markets. With a broad constituent base of 1,377 securities, this index works well as a bellwether of the global market.

As a reminder, Total Risk is a measure of the combination of individual stock risk and factor risk in the market. We're not only considering volatility, but also the correlation between securities and factors.

With that in mind, let's now take a look at Total Risk for the ACWI over the past year.

Over the past 12 months, global risk fell from 11.4% to a trough of 9.17% on 10/3/18. The market contraction that followed caused risk to jump to a peak of 15.5% on 1/18/19. It then slowly started to decline over the next few months, and then started to fall at a much steeper rate at the beginning of April. Total Risk now sits at 12.94%, almost 3% lower than the US market (15.72% as of 4/18/19).

If we look at contribution by country, we can see that the recent reduction is risk has been driven by declines in the ACWI's top two risk contributors — the US and Japan, along with muted risk among the rest of the field.

For more context, let's extend the Total Risk chart back to Factormageddon 2016:

Total Risk worldwide peaked at 18.3% after Factormageddon 2016 (compared to the US at 18.15%). It then fell to 15.2% on 6/13/16 before spiking back up to 16.56%. It fell dramatically over the next 18 months, hitting a bottom of 6.3% at the end of 2017 and then rocketing back up in the early months of 2018. The October swoon drove risk higher, peaking at 15.5% in January and then slowly declining until April. Starting April 4, we've seen precipitous drop in global risk, which now sits at 12.94%.

One thing to note is that unlike the US market (where risk peaked above 18% in both Feb 2016 and Jan 2019), total global risk at the end of 2018 never approached the same heights seen during Factormageddon.

‍Conclusions

‍Total Global Risk remains elevated, but less so than in the US. Similar to what we observed in the US, we see that the initial slope of the decline in global risk in January was slower than what we saw during the recovery of early 2016. The rate of risk reduction has really picked up as of late, with risk falling 1.72% over the past two weeks. We'll continue to monitor this trend to see if the chart is telling us investors are truly coming back into the worldwide market.

Regards,
Omer