Your Exposure to the New Economic Order - Part II

For the last two weeks, we have leveraged our access to over 150 style and 400 sector factors to measure the market reaction to Russia’s invasion of Ukraine. This week, we’ll be providing an update on the significant factor trends we see through the lens of our Surprise Metric. We will also introduce our Surprise Characteristics Indices, which will help quantify the reaction trade's risk and performance and measure the sensitivity of assets to the new economic order.

The Surprise Metrics below measure each factor’s return divided by its predicted standard deviation. On a trailing one-week basis and since the invasion on February 24th, we continue to see multiple standard deviation moves across a broad number of factors, marking the significance of the market's response to the crisis.

Commodities and Inflation Fears Driving Styles and De-Leveraging

Even though Crude Oil prices pulled back this week, the Commodity and Inflation factors in the Axioma Worldwide Macro Projection risk model still rise to the top of the positive surprise list. This top ranking is due to renewed inflation fears stemming from increasing commodity prices combined with a likely less aggressive FED.

Wolfe's crowding factors point to the de-leveraging of hedge fund managers, which has resulted in systematic headwinds for investors over the last couple of weeks. For example, the Short Interest factor in the Wolfe QES US v2 risk model shows a surprise of 2.28 since the invasion, while the HF Crowding factor in the same model has seen a -1.65 surprise. These indicate that heavily shorted stock prices are rising and heavily crowded long stock prices are rapidly falling as managers cover shorts while simultaneously unwinding long positions.

While the Growth/Value trade has calmed a little this past week, growth factors seem to have diverged as growth is being sold off globally but is rallying in the US. Value factors have rebounded a bit this week, mainly Developed ex-US Dividend Yield and US Value.

Top Style Factor Surprises

Industry Trends Continue in the Same Direction

The trends across sectors and industries have been remarkably consistent. Investors continue to move into Utilities, Industrials, Materials, and Energy and out of Consumers and Financials. The industries with the most notable surprises are listed below.

Utilities and Industrials have experienced multiple standard deviation tailwinds across every underlying industry except Airlines. Electricity-centered industries and Aerospace & Defense stocks have been the leaders, with surprise metrics above 6 standard deviations since February 24th!

Financials feel the pressure of increased inflation fears and the unlikelihood of steep rate hikes in the short term. However, the consumer sectors have been the biggest losers. Consumer Discretionary headwinds are likely part of the defensive vs. cyclical trade, but Consumer Staple's challenges likely point to supply chain issues and the rising costs of raw materials.

Top Industry Factor Surprises

Omega Point’s Surprise Characteristics Indices

Last week, we discussed the challenge managers are having when measuring their sensitivities to the Russia/Ukraine crisis. The massive crash in Russian stocks resulted in a total de-coupling between the Russian and global markets. Calculating a stock or portfolio beta to a Russian index would yield useless noise. Instead, we chose to leverage the reaction to the crisis through these factor surprises to construct market-neutral indices that are long positive surprise factors and short negative surprise factors. The factors are equally-weighted on both the long and short sides so that the resulting indices are 100% long and 100% short.

Because the market reaction changes over time, we are rebalancing these indices every Friday to account for the changes in cumulative surprise metric levels across all factors.

We display the performance of the indices below. All versions are up more than 5% over the last ten trading days despite a minor correction toward the latter end of this week when growth and value began to converge along with HF Crowding and Short Interest. The volatilities of the indices vary based on the factor inclusion threshold used. As fewer factors are incorporated, the volatility increases, reaching 17.9% annualized for the 99th Percentile Index.

Quantifying Exposure to the New Economic Order

In addition to constructing the indices themselves, we have also calculated a predicted beta for over 7,000 stocks and ETFs to the indices. The predicted beta will give managers a better sense of how they are positioned in this new market environment. Below, we've highlighted a list of some of the most heavily-traded ETFs. We also included their predicted betas to each version of the surprise indices. A positive beta indicates that the ETF is likely to benefit from the factor trends we have seen since February 24th, and a negative beta suggests that the ETF is expected to face headwinds.

Nearly all of the ETFs have negative predicted betas to the indices, but there are a couple of standouts. On the negative side, the ARKK Innovation ETF and the Consumer Discretionary SPDR Fund have exceptionally negative betas. The betas to the 87th Percentile Index, for example, are -1.22 and -0.99, respectively. In other words, if the index has a +1% return, these ETFs can be expected to move down by -1.22% and -0.99%, respectively.

The Energy SPDR Fund is by far the standout on the positive side with significantly positive betas across all indices. Although it’s to a lesser degree, the Utilities SPDR Fund is also poised to see tailwinds in the current landscape.

As the tragic events continue abroad, we hold out hope for a de-escalation of violence and safety for all of those affected. In the meantime, and as a service to the investment community, we will continue to update Factor Spotlight readers on breaking market impacts that we uncover. In addition, we will be dynamically maintaining these indices, which our customers can access to better understand the ongoing effects on their portfolios.

If you would like to learn more about our research or analyze your portfolio through the lens of our predicted beta framework, please don't hesitate to reach out.

US & Global Market Summary

US Market: 03/04/22 - 03/11/22

• Most of the major US equity indices closed lower during another tumultuous week of trading, with the DJIA down 1%, while the S&P and Nasdaq fell 1.8% and 2.2%, respectively. An exception was the Russell 2000, which rose 1.4% for the week.
• Markets were pressured by uncertainty about the war in Ukraine and expectations that the Fed will hike U.S. interest rates next week.
• The U.S. announced a ban on a wide array of Russian imports and made it harder for Russia to access funds from the IMF, as Washington and its allies ramped up sanctions.
• U.S. consumer sentiment fell in early March by more than expected on inflation concerns.
• Consumer prices in February notched their largest annual increase in 40 years.
• Oil futures continued to soar, hitting peak levels not seen since 2008, but pulled back sharply on Friday as additional supply looked to come online.
• The US dollar, oil, gold, silver, and copper closed higher on the week, while natural gas closed sharply lower.

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

• Medium-Term Momentum and Growth remain on an upward tear, switching up the previous week’s 1-2 spots once again, as they both crossed the overbought threshold.
• Value continues its recent downward spiral and entered oversold territory.
• Size continues to plummet crossing into extremely oversold terrain and secure this week’s bottom spot.
• U.S. Total Risk fell 0.06% this week.

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

• Medium-Term Momentum and Growth, in unusual sync with their US factor counterparts once again, switch up last week’s 1-2 spots and continue to build on their impressive runs of late.
• Earnings Yield broke out of a ten-week slide to rise 17 BPs and exit oversold territory.
• Exchange Rate Sensitivity slid once again putting its scorching climb extinguished one month prior even further in the rear view.
• Market Sensitivity (beta) fell for the second straight week following a 10-week climb as it nears the negative threshold.
• Value missed finishing at the bottom of the leaderboard for a 5th consecutive week but continues to plummet to cross into oversold terrain.
• Size dropped like a rock once for week #2 and mirrored its US counterpart to finish last while crossing into extremely oversold territory.
• Global Total Risk rose 0.02% this week.

Regards,
Kevin