You Can Run, But You Can’t Hide From Runaway Volatility

Last week we had focused on Volatility’s first major trend reversal since the Financial Crisis, adding its bullish 2020 turnaround to the growing list of unusual market behaviors we’ve seen in the COVID era. We compared sector drivers and correlations between today and 2009, and uncovered startling disparities alongside some remaining scraps of common ground. This week, we dig deeper into the securities behind Volatility’s upward trend and try to get a better handle on what is driving its performance.

‍Volatility’s YTD Performance
Volatility continues its bull run this week, inching up 2 bps since last week to 6.28% YTD performance. This movement stands in stark contrast to its cumulative -56.6% slide since 2007.

Runaway Volatility

In continuing to analyze the DNA of the Volatility factor, we have seen a 'runaway Volatility' effect, where securities with historically low exposure to Volatility are showing major increases to the factor. We saw something similar with Beta earlier in the year and a similar effect has now spread to Volatility.

Drawing from the sector analysis from last week, we started by analyzing the highest Volatility names within the top 3 sector groups in the high-minus-low (HML) Volatility portfolio. These sectors were Financials, Energy, and Health Care.

For Financials, the security with the highest Volatility exposure is Siebert Financial Corp (SIEB). SIEB has seen a huge increase in Volatility exposure, jumping almost 1.5 standard deviations on a YTD basis.

The top names in Energy and Health Care saw similar trends in Volatility exposure, with Gulfport Energy (GPOR) seeing an increase of over 1.5 standard deviations and Inovio Pharmaceuticals (INO) increasing by close to 2.5 standard deviations.

Interestingly, it’s not only the current high Volatility stocks that are seeing these drastic shifts in exposure, but stocks that have had high exposure to this factor previously no longer do, and stocks that used to carry low exposure are at long last joining the high Volatility group.

Volatility is Running Rampant Everywhere

Possibly more relevant than the high Volatility names that are becoming even higher Volatility are the names that are completely switching direction.

To check for this, we also looked at names that were historically high (or low) Volatility stocks to see if they’ve changed direction. We froze the long (high Volatility) and short (low Volatility) sides of the Volatility HML as of April 2 (the day Volatility started rallying) and created two long-only equal-weighted portfolios. We rebalanced these portfolios to ensure they stayed equal-weighted and then tracked the Volatility exposure over time.

Based on the charts, we see runaway Volatility working its magic (or dark magic, depending on your perspective) in both directions.

The average Volatility exposure of for the low Volatility names increased over 0.5 standard deviations from -0.74 to -0.23.

For the high Volatility portfolio, we see a similar trend, though in the opposite direction. High Volatility names as of early April actually decreased their Volatility exposure on average! Names that were historically high Volatility decreased exposure by almost 0.25 standard deviations on average from 1.74 to 1.53.

This analysis illustrates that we’re in an environment of wild swings in Volatility. Seemingly any name is susceptible to runaway Volatility and while the directionality of the forward exposure change could go positive or negative, it’s clear that many of the movements we’ve seen and will continue to see are likely to be drastic. Given these changes in Volatility exposures, it’s imperative that investors are diligent in monitoring Volatility exposure in their portfolios and leveraging factor aware portfolio construction where possible.

‍In two weeks we’ll wrap up our series on Volatility by analyzing whether high Volatility or low Volatility names are driving the performance reversal and try to understand the impact, if any, on the low Volatility investing phenomena that has grown in popularity over the past several years.

US & Global Market Summary

US Market: 8/24/20 - 8/28/20

• Major stocks indices wrapped up another strong week as the Dow Jones Industrial Average reached positive territory for the first time since late February.
• The week also marked the S&P 500′s first five-week winning streak since late 2019 and the longest run for the Nasdaq since a six-week win streak that ended in January.
• The Federal Reserve unveiled a major policy shift on Thursday allowing inflation and employment to run higher to continue to support the economy. The move indicates that interest rates are likely to stay near zero for a long period of time.
• U.S. consumer spending rose 1.9% in July, topping a Reuters forecast of a 1.5% gain. Personal income was also stronger than expected, rising 0.4% while economists had forecast a drop of 0.2%.
• The Trump administration is reportedly fast-tracking a Covid-19 vaccine prior to US election and The US Food and Drug Administration issued an emergency use authorization for convalescent plasma — blood plasma taken from coronavirus survivors — to treat the virus.

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

• This week’s headliner Volatility also sits at the top of the US factor charts for the third week in a row sharing this week’s biggest normalized gains with Market Sensitivitywhich (just as impressively) continues its march towards positive territory for the seventh consecutive week.
• Rebounding from last week’s dip into negative territory, Size slips back above the mean this week.
• Growth continues its four-week slide towards oversold terrain.
• Momentum saw the biggest normalized loss this week continuing its abrupt reversion since a peak on 8/6.
• US Total Risk (using the Russell 3000 as proxy) declined by 116bps, breaking below levels last seen in mid March.

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

• Market Sensitivity continues a six-week rally towards positive territory and sits alone atop this week’s leaderboard.
• Size is finally showing some upward pressure after a five-week slide deeper below the mean.
• Growth advanced for the second week but still resides in Oversold territory.
• Profitability’s seven-week march deeper into positive territory came to an abrupt halt this week.
• Momentum was once again the week’s biggest loser continuing its fall from a peak of +2.58 SD on 8/5.
• Global Risk (using the ACWI as proxy) declined by 51bps.

Regards,
Alyx