Where’s the Macro?

Throughout 2021, we’ve explored a variety of macroeconomic influences on equity risk and performance, from interest rates to inflation, commodities, and more. Of course, the magnitude of the macro role in equity markets fluctuates over time but, for many, it has felt as though macroeconomic factors have been a massive driver of performance for nearly two years running. As a result, as fundamental managers continue to explore the macro risks in their strategies, they raise two key questions: Where is macro dictating returns, and where is the alpha?

To help answer these questions, we will be leveraging specialized macro datasets from our partners at Quant Insight.

Quant Insight (Qi) provides macroeconomic models to deliver factor exposures, risk decompositions, asset valuations, and more across a multi-asset class landscape. Qi’s macroeconomic factors span Financial Conditions, Economic Fundamentals, and Risk Appetite on a global scale to help better explain asset volatility and return.

In our “Where’s the Alpha?” editions of Factor Spotlight, we’ve used fundamental risk models to identify stocks that are heavily factor-driven and stocks that are heavily alpha-driven. This week, we'll take a similar approach but reimagine the analysis through the lens of macroeconomic factors that have significantly impacted equity markets.

EXPLANATORY POWER

To illustrate the degree to which macro factors influence a stock’s risk, Quant Insight calculates a model R-Squared value. The R-Squared metric measures the “fit” of the model on a given asset and explains the percent of variance attributable to macroeconomic factors. For example, a 100% R-Squared means that the asset's price movement is entirely explained by macro, while an R-Squared of 0% means that the asset's price movement is completely idiosyncratic. Quant Insight defines a stock with R-Squared > 65% in 'macro regime.'

To start, let's take a look at the Russell 1000 Index. The chart below tracks the R-Squared value for the index on a weighted basis. In March 2020, the model moved deep into macro regime, which remained for much of 2020. Then, just as macro influence was waning at the beginning of 2021, the model R-Squared spiked again, indicating that macro factors had taken hold of equities once again. What we’ve seen since March, however, is a steady decline. Could this point to more alpha availability in the market?

Russell 1000 Index Quant Insight R-Squared

WHERE’S THE MACRO?

Using a broad index gives us high-level intuition around the macro landscape, but we know that its market-cap-weighted nature results in a small number of mega-caps dominating the story. To combat this, we grabbed all US stocks within the Quant Insight coverage universe (~1,700) from December 2019 to the present and observed the distribution of R-Squared values.

The box and whisker plot above highlights the increases in macro's influence in March of 2020 and February of 2021 and the decline from March 2021 to date. What we find in addition is that the dispersion of R-Squared across the US equity universe has also been very dynamic. In March of both 2020 and 2021, for example, nearly all stocks were at least ~35% explained by macro factors with median R-Squared values of 74% and 84%, respectively. However, as of November 30th, stocks have a much wider range, which translates to an expanded universe of heavily macro-driven and heavily alpha-driven stocks.

Observing the percentage of macro-driven stocks (R-Squared > 65%) over time confirms that intuition. For example, in February of this year, over 75% of stocks were considered in "macro regime" vs. less than 45% today.

THE SECTOR STORY

Different macro factors impact sectors differently. For example, interest rates have moved Financials and Real Estate; commodity prices have influenced Energy; global economic outlooks have affected global companies. As a result, it is important to disaggregate the universe to understand these trends deeper.

Sector Median R-Squared

While every single GICS sector has seen a decline in median R-Squared from macro’s peak in March 2021 to the present, Energy and Real Estate stand out as the most significant drops. As of March 31st, macroeconomic factors have dictated more than 90% of the median stock's price volatility in Energy and Real Estate!

Managers were likely struggling to find stock-specific alpha as systematic economic forces were moving these names. As of November, both median R-Squared values fell to 56%, out of "macro regime." On the other hand, Information Technology has been more consistent, and we continue to see similar levels of macro influence within the tech sector.

In aggregate, macro influence is subsiding, but it is dangerous to paint broad strokes. There may be ex-macro alpha, but we need to dig deeper to find it. We extracted the stocks in Energy, Information Technology, and Real Estate to spotlight the variability that exists intra-sector when it comes to the amount of macro risk that stocks are taking on today.

In the chart below, we see that nearly half of Energy and Real Estate stocks have R-Squared values between 35% and 65%, but 37% of Energy stocks and 33% of Real Estate stocks are still in "macro regime" despite a broader decline in macro influence in these sectors. Managers should tread lightly and be aware of the macroeconomic factors that might contribute significantly to their portfolio performance.

MACRO RISKS HAVE FAR FROM VANISHED

Some of these names have even seen significant increases in macro risk of late. The most noteworthy move into "macro regime" in Real Estate, for example, was an increase in R-Squared from 20% to over 80% on a trailing 5-month basis.

The GEO Group, Inc. (GEO) Quant Insight R-Squared

During that period, factor sensitivities picked up in a few critical areas for this particular stock. More significant negative correlations to interest rate spreads, China GDP, and Iron, along with positive correlations to the US Dollar, China CDS, and volatility, have been leading contributors to price movements in the stock.

Not all stocks carry the same macro DNA. That notion holds even for stocks with similar industry and fundamental characteristics. As a result, fundamental managers can enhance their risk awareness and management by incorporating macro factors and models into the portfolio construction process. In the coming editions of Factor Spotlight, we will continue to unpack the macro environment and its ever-evolving relationship to the equity world.

If you are interested in exploring Quant Insight’s data or would like to evaluate your portfolio through the Omega Point platform, don’t hesitate to reach out.

‍US & Global Market Summary

US Market: 11/29/21 - 12/04/21‍

• Wall Street closed out a bumpy week despite a rebound on Thursday that saw the Dow rise more than 600 points, but finished the week down 0.9%. The S&P 500 fell 1.2%, and the Nasdaq Composite lost 2.6%.
• Fed Chairman Powell told a Congressional panel that the central bank will consider speeding up the taper of its $120 billion monthly bond-buying program when it meets Dec. 14 and 15.
• November’s jobs report showed slower-than-expected job creation last month. Nonfarm payrolls increased by just 210,000 for the month, well below the 573,000 jobs predicted by economists.
• The number of Americans filing new claims for unemployment benefits rose less than expected last week while layoffs tumbled to a 28-1/2 year low in November, both signs of tightening U.S. labor market conditions amid an accelerating economy.
• Congress’s passage of a short-term extension of government funding, through Feb. 18, averting a partial shutdown after resolving a standoff over vaccine rules.
• West Texas Intermediate crude for January delivery fell 0.4% Friday to settle at $66.26 a barrel, notching a sixth straight week of declines.

‍Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)‍

• Earnings Yield builds upon its 9-week upward tear this week, landing at +1.78 SD above the mean and just within sight of extremely overbought status.
• Profitability continues its positive run to move midway through overbought territory - a far cry from its negative status only one month prior.
• Medium-Term Momentum moved up for a 6th straight week to land at +0.55 SD above the mean.
• Value and Volatility continues their slide of late and move closer to oversold terrain.
• Market Sensitivity repeats its last place finish prior to the holiday to officially slide into oversold status.
• US Total Risk jumped by 0.84% this week.

‍Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)‍

• Growth leads the global pack this week as it moves towards the mean and further away from its oversold status just 3 weeks prior.
• ‍Earnings Yield and Size both continued their upward runs to move deeper into overbought terrain.
• ‍Momentum moved upwards for the 6th straight and sits at +0.40 SD above the mean.
• ‍Profitability slowed down its rocket-like ascent of late but moves up for the 6th consecutive week and sitting within reach of the extremely overbought threshold.
• ‍Volatility leaves the positive column to finish the week at -0.28 SD below the mean.
• ‍Market Sensitivity (Beta) continued its trend of recent weakness and now sits well in negative territory.
• ‍Exchange Rate Sensitivity once again saw a large slide to finish the week in last place and move into oversold status.
• ‍Global Total Risk jumped by 0.75% this week.

Regards,
Kevin