The Market Reacts to Inflation with Sector Realignment

Over the last month, we've introduced Extreme Movers, the latest tool in our arsenal to understand what is driving markets from week to week. Two week's ago, 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. In addition, due to a highly unusual realignment we're seeing in the markets, this week we've applied our Surprise Metric to help better understand the market's follow-on reaction to the CPI data released on June 10.

US Market Summary and Extreme Movers Metrics

US Market: 06/17/22 - 06/23/22

• Major US indices rebounded strongly this week. The Nasdaq led the way, posting a 5.5% return, while the S&P 500 and Dow followed at 3.5% and 2.5%, respectively.
• A consumer sentiment survey by the University of Michigan showed a reduction in inflation expectations following the Fed’s announcement on May 15th, from 5.4% down to 5.3%.

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’s streak of increasing returns ended this week, falling back below its year-to-date median to 17.8%.
• Alpha contribution, however, continued its downward slide, adding only 8.5%, which marks the its lowest tally since mid-April.
• This past week was the most industry-driven so far this year. Industry factors contributed almost one-third of the portfolio's overall performance, which points to a significant realignment across the market.

• The International Extreme Movers Portfolio also saw a decreased return this week, snapping its four-week streak of increased returns.
• Like in its US counterpart, industry factors showed a spike in performance contribution this week to 17% from 6% the week prior.

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 showed the most significant single sector concentration we’ve seen in 2022. Health Care represented a 43% net long position in the portfolio, up from 8% a week prior.
• Information Technology was the second-largest overweight, representing a significant rebound from last week when it was the second-largest underweight at -14%.
• The portfolio was significantly short Energy, the most prominent long position on average in 2022 as the portfolio rode the wave of rising oil and gas prices.

• The see-saw action in style factors continued this week as the US Extreme Movers portfolio reversed course again.
• The portfolio moved back into high volatility, less profitable growth stocks and away from less volatile value-oriented stocks.
• Despite the rate hike announcement from the Fed on the 15th, the portfolio posted its most significant underexposure to the Interest Rate Beta factor in 2022, leaning into stocks that typically benefit from lower rates.

• The International Extreme Movers portfolio was also long Health Care and short Energy and Materials. However, the net position amounted to about one-third of the level of its US counterpart.
• The most considerable directional disparity was in Information Technology. The International portfolio held a 6% net short position in tech relative to the 11% net long position in the US version.

• Like the US portfolio, the International portfolio also moved back into higher volatility and away from value.
• Despite a sharp reversal against Earnings Yield, the International portfolio maintained an underexposure to growth which varied from the US version.
• Another consistency point was in Interest Rate Beta, where the portfolio aligned itself with stocks that typically benefit from declining rates.

Industry Surprise

Given the dramatic sector realignment this week, we decided to apply our Surprise Metric, which is the ratio of a factor’s return relative to its predicted volatility. The Surprise Metric allows us to measure the market’s reaction to a particular event.

For this week's analysis, we calculated the Surprise Metric for industry factors across risk models from our partners at Qontigo, MSCI Barra, and Wolfe QES from the June 10th publication of the CPI data through this past Wednesday, June 22nd.

Industry Factor Surprise Metric (6/10/2022 - 6/22/2022)

• Health Care Technology and Biotechnology were the positive Surprise leaders, posting +3 standard deviation moves in the US and globally.
• Food Products and Beverages followed closely behind with very substantial +2 and +3 standard deviation Surprises.
• On the downside, Trading Companies & distributors were the hardest hit in terms of Surprise Metrics across all markets, followed by Energy industries which had previously been far and away the biggest winners of 2022.

Regards,
Kevin