Sectors Driving Geopolitical Risk

Last week, we introduced the Geopolitical Risk Factor (GRF) and analyzed its performance over the past three years. This week, we decompose this factor into its sector exposures in order to assess whether any specific sectors are associated with positive or negative movements in the factor.

We’ll also provide our weekly market and factor updates.

Methodology

‍To analyze the Geopolitical risks factor characteristics, we ranked all names in the Russell 3000 by their geopolitical risk exposures and created a theoretical portfolio that was long the top 1000 names (1/3rd) and short the bottom 1000 (1/3rd).

As we established last week, investment managers should make it a high priority to stay on top of the potential impacts that geopolitical risks may have on their portfolio due to the massive amounts of geopolitical variables that are in play. The chart below shows how exposure to the GRF factor has trended at the sector level:

‍Historical Exposure: Healthcare & Consumer - 1/1/17 - 1/31/20

We observe that the defensive sector, Health Care, tends to be positively exposed to movements in the Geopolitical Risk Factor, while Consumer Discretionary tends to be exposed negatively to movements in this factor. This seems to make sense — when Geopolitical tensions rise threatening economic growth, investors will marginally shift funds to companies that will be needed during an economic downturn, while shifting funds away from companies that rely on discretionary spending fueled by calm and comfort.

Historical Exposure: Energy & Financials - 1/1/17 - 1/31/20

On the other hand, the Energy and Financial sectors are far more context dependent in their exposure to geopolitical risk. In early 2017 after the election, both appeared to be positively exposed, and then dropped to a negative exposure over the next year. Financials continued to drag downwards, while Energy has once again become positively exposed.

Applying a sector decomposition allows us to identify particularly sensitive sectors. As we continue this series, we’ll zero in on these particular sectors and how you can best safeguard your portfolios against significant moves due to these geopolitical risks.

US & Global Market Summary

US Market: 1/24/20 - 1/30/20

• The US market saw weakness on Friday (not captured in above chart) as fears that the Chinese coronavirus pandemic would slow economic growth hit investors, leading to some of the biggest drops since August 2019.
• US consumer spending rose slightly in December, but the increase in outlays in 2019 was the smallest in three years.
• The January Chicago PMI dropped to 42.9m from a previous indication of 48.9 indicating lingering weakness in the manufacturing zone.
• The FOMC announced Wednesday that it would keep rates in the current target range of 1.50% to 1.75%, as the economy continued to “rise at a moderate rate.”

Factor Update: Axioma US Equity Risk Model (AX-US4)

• Profitability continued its recovery, albeit at a slower pace than had been seen recently.
• Growth saw slight positive gains, as it creeped up further into Overbought territory.
• Volatility and Market Sensitivity both saw weakness, with Market Sensitivity falling further into Oversold space.
• Earnings Yield continues to be an Extremely Oversold factor.
• The rotation out of Value continued, as it fell away from -1.05 to -2.05 SD below the mean, well into Extremely Oversold territory.
• US Total Risk (using the Russell 3000 as proxy) fell by 0.27%

Factor Update: Axioma WorldWide Equity Risk Model (AX-WW4)

• Growth continued its ascent, up 0.16 standard deviations in the past week and now sitting in Extremely Overbought territory.
• Similar to the US, Volatility and Market Sensitivity both saw negative normalized returns, with Market Sensitivity on the cusp of Oversold territory.
• Similar to the US, Value saw over a full standard deviation downtick in normalized returns, now on the precipice of an Extremely Oversold label.
• Global Risk (using the ACWI as proxy) decreased by 3bps

Regards,
Omer