Rate Hikes and Recession Fears Grip Markets

Over the last few issues of Factor Spotlight, we've introduced Extreme Movers, the latest tool in our arsenal to understand what is driving markets from week to week. Last week we debuted an international version of the Extreme Movers portfolio to help investors compare fluctuating alpha opportunities and factor-driven dynamics between the US and the world. The Extreme Movers portfolios allow us to apply hindsight to the prior week's momentum to understand the following key questions better:

1. Was the preceding week an alpha-driven or factor-driven week?
2. What are the factor characteristics of the stocks that drove the market?

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

See below for this week’s Market Summary recap and Extreme Movers portfolio summaries. Also, don’t hesitate to reach out if you want to understand more about the Extreme Movers portfolio or apply our methodology to a customized investment universe.

US Market Summary and Extreme Movers Metrics

US Market: 06/10/22 - 06/16/22

• All major indices fell dramatically this week. The Nasdaq fared the worst, down -9.4% through Thursday, while the S&P 500 and Dow were down -8.7% and -7.3%, respectively.
• The Fed announced a 75 basis point hike in its benchmark interest rate on Wednesday, marking the steepest hike since 1994. It also noted that it had not ruled out another 75 basis point hike as it does everything in its power to curb record levels of inflation.

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, there are several areas we want to observe around weekly performance:

1. Is the weekly performance below or above the recent median weekly performance? Above the recent median means that the Extreme Movers portfolios had much higher dispersion than a typical week, most likely driven by higher factor volatility.
2. Is the weekly alpha contribution below or above the recent median alpha contribution? Above the recent median demonstrates that the significant market moves were more alpha-driven than in a typical week. Below the median, the market moves were more factor-driven than in a typical week.

• The US Extreme Movers portfolio saw another uptick in performance for the second week in a row, rising just above its year-to-date median of 18.4%.
• Alpha contribution decreased for the fourth week, falling well below its median to 60%.
• In its place, style factors increased in contribution from 20% to 29% due to a heavily beta and residual volatility-dominated market environment.

• The International Extreme Movers Portfolio also saw an increased return this week, maintaining a four-week streak of rising performance.
• Like in its US counterpart, Alpha contribution has fallen off as well in favor of systematic factor contribution, reaching over 47%. This week marks the lowest alpha contribution in the International Extreme Movers portfolio in 2022.
• Though style factor contribution increased this week, currency contribution made the most significant jump, contributing 13% of the portfolio’s return. Significant gains in the Euro and Swedish Kroner drove 50% of the move in this factor category.

Extreme Movers Portfolio Exposure

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.

• This week, the most significant sector shifts in the US Extreme Movers portfolio were big moves into Consumer Staples and out of Information Technology.
• Real Estate, which had been the biggest underweight last week, ended up slightly net long this week, replacing favorable positions in Industrials, Consumer Discretionary, and Energy.

• Regarding style factors, the portfolio made a complete 180 this week, moving harshly away from beta, volatility, and growth and into value and quality.
• The exposure to size also flipped from negative to positive as investors moved away from speculative small-cap growth stocks into large-cap value.
• Last week, long crowded stocks did well, but this week, the portfolio was short both long and short crowded stocks as it took advantage of a likely deleveraging among hedge fund managers.

• Directionally, the International Extreme Movers portfolio rebalanced similarly to the US version but varied in magnitude.
• Financials saw a much stronger push in the International portfolio, reaching a 27% long position, the largest this week by far.
• Real Estate represented the sector with the most significant misalignment. Despite a large long position in the US portfolio, the International portfolio remained consistent with a small short allocation to the sector.

• Like the US portfolio, the International portfolio flew from high beta and high growth into larger cap, high value stocks.
• The International portfolio also made a much stronger move toward names that will benefit in a rising interest rate environment, which we haven't seen to the same degree as the US portfolio yet.

Regards,
Kevin