Risk-on Back in Vogue on Easing Inflation

Over the past several months, we've introduced Extreme Movers, the latest tool in our arsenal to understand what is driving markets from week to week. We also 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 22 edition of Factor Spotlight.

‍US Market Summary and Extreme Movers Metrics

US Market: 11/11/2022 - 11/17/2022

• The US market had a strong finish last week but remained relatively neutral over the five days ending Thursday. The Nasdaq fared the best, returning 0.3%, while the S&P 500 and Dow finished in the red at -0.3% and -0.5%, respectively.
• Following last week’s CPI-driven market rally, FED officials reiterated their intent to continue with rate hikes given “unacceptably high inflation.” This announcement and rising tensions between Russia and the NATO Alliance divided investors' demand for equities this week.
• According to Friday's economic release, US existing home sales declined for the ninth straight month. Mortgage rates fell sharply this week, but high rates and persistent inflation continue to curb the housing market.

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 a strong return of 27.7% this week, which is in the 93rd percentile of returns YTD.
• In contrast, the alpha contribution was one of the lowest of the year, with just 57.6% of the weekly return attributable to idiosyncratic return. This level represents the lowest alpha contribution since the week of August 24.
• Investors piled into high-beta and low-momentum stocks on Thursday and Friday last week to ride a recovery in beaten-down names following Wednesday's CPI release.
• The style posture of the portfolio led to long positions in Info Tech and Consumer Discretionary, which led the industry factor contributions.

• The International Extreme Movers Portfolio returned 30.2% this week, which is in the98th percentile of returns YTD. Only the week of March 2 saw a higher total return.
• Alpha contribution was the lowest of the year, at 46%. This level also marks the only week where factor contributions outweighed alpha this year.
• Style and Country factors led the systematic volatility in the international markets. Like the US portfolio, beta and momentum factors were the key style drivers, while an overweight to China and an underweight to Brazil accounted for most of the Country performance.

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.
To provide a relative perspective on the size of the exposures, we’ve adjusted the third column from YTD Average to YTD Ptile (“percentile”). With >200 trading days into the year, we’ll highlight any exposures that are in the top 10 trading days (95%+) or any exposures in the bottom 10 days (<5%).

• Information Technology saw a sharp recovery vs. last week's significant short allocation as investors moved heavily into Software and IT Services stocks. This week's long allocation places it at the 95th Percentile YTD.
• Financials had the most significant short allocation seen all year, driven almost exclusively by Insurance and Banks, which have been low beta, high momentum, and highly rate-sensitive.
• Health Care also accounted for a considerable proportion of the short book. Pharma, Biotech, and Health Care Providers & Services industries led this short allocation. Conversely, HC Equipment and HC Technology featured in the top-10 Industry exposures, showing some dispersion within the Health Care sector.

• As noted above, the US Extreme Movers portfolio had significantly positive exposures to beta factors. These were driven primarily by the long allocations to Information Technology and Consumer Discretionary, but all sector allocations positively contributed to Beta exposure.
• Value factors took a massive hit this week. Earnings Yield and Dividend Yield placed lower than their 15th Percentiles YTD in all three factor models. On the flip side, Growth saw upward price pressures, with the average exposure to Growth sitting at the top Quintile YTD.
• The portfolio had positive exposure to all crowding factors. Most notably, the positive exposure to Short Interest was driven by long positions in heavily shorted hedge fund stocks, resulting in adverse pricing pressure against managers.

• Similar to its US Counterpart, the International Extreme Movers portfolio saw a massive long allocation to Information Technology at 96th Percentile YTD. This allocation was spearheaded almost exclusively by the Semiconductor and IT Services industries.
• Other notable long-sector allocations were Health Care, Real Estate, and Consumer Discretionary. The latter mainly came from the Internet & Direct Marketing Retail, Hotels, Restaurants & Leisure, and Textiles & Apparel industries. On the short side, Automobiles and Multiline Retail had a significant presence.
• Financials also followed the trend seen in the US portfolio, with a short allocation of -15% of the portfolio. The Banks industry accounted for almost all of this short allocation.

• The “risk-on” trade was also evident in the international portfolio as it gravitated dramatically toward riskier high beta and high growth stocks.
• Unlike the US counterpart, the international portfolio stayed positively exposed to value factors, signaling somewhat of a GARP posture.
• Interest rate-sensitive stocks continued last week's trend, plunging as investors started to sense the possibility of a less aggressive central bank policy.

Regards,
David