I hope you enjoyed the holidays and year-end festivities. Today, we'll provide a factor update spanning the past two weeks, a period characterized by sustained choppiness in the market and mixed economic headlines. Just this week, AAPL dramatically lowered 1Q revenue guidance, citing “economic deceleration,” particularly in China. and the ISM Manufacturing Index's significant December put a large dent in investor sentiment. Friday saw a strong December jobs report and comforting words out of the Fed, allaying investor's fears and sparking the second major market rally in just as many weeks.
While we primarily cover factors here, it's vital to understand what the fundamentals of the environment are showing, and the news has been somewhat schizophrenic on that front as of late. One thing is certain: the word “recession” is being thrown around much more these days, and investors are preparing themselves for a market that looks more like 4Q2018 than the constant drift upwards we had seen previously.
The US Market factor (99% correlated to the S&P 500) saw continued weakness after falling nearly 7% the previous week. The slump in the days before Christmas were answered by a brief rally, then came the AAPL and ISM news. Friday hasn't been captured in the model yet, but the S&P 500 shot up 3.43% on the positive macro datapoints at the end of the week.
Here's a look at how some key factors we've been tracking have changed in our normalized return indicator. While the macro and earnings picture might be muddied, most factors actually staged a major rally on a normalized basis:
As we've discussed since the very beginning of December, Profitability was Extremely Oversold on a normalized basis, bottoming out at -2.89 standard deviations below the historical mean on Dec 17th. Since then, the factor has seen a substantial rally, up 1.13 standard deviations since Dec 20. The upward reversion appears to be continuing, as the factor is still in Oversold territory. This move may reflect a flight to quality as the recent market volatility has spurred investors into seeking risk-off assets.
On a cumulative basis, the factor was up 0.19% since Dec 20, as of EOD Thursday.
The second biggest beneficiary of the post-Dec 26 factor rally, Volatility ended up +0.72% on a cumulative basis since Dec 20, even after Thursday's negative datapoints chipped away at the gains.
On a normalized basis, the factor went from -0.26 SD below the mean on Dec 20, to +0.33 SD above the mean as of the Jan 3 close.
While the recent positive moves in Volatility may have a palliative effect on some investors' risk appetites, we continue to see the wisdom in managing risk from Volatility in today's environment. As our friend Melissa Brown lays out in the Axioma blog, minimum variance strategies have played out well during the recent market downturn.
We'll continue to monitor these factors and will be back next week with an update to see what other trends we can divine from the intersection of factor movements and the economic news that the markets will continue to act on. If you'd like to see what your portfolio's relationship is with any of these factors, or would like to better understand how you can mitigate factor exposure, please don't hesitate to reach out.