Last week, we highlighted that the growth vs value spread has recently hit a high point since 2005, which led us to dive deeper into what might be causing this trend. We used the J.P. Morgan iDex U.S. Growth Index and J.P. Morgan iDex U.S. Value Index, which are much purer representations of growth and value than standard style indices, and found that the beta profile of these investment styles has changed significantly over the past year. We also found that the levels of idiosyncratic risk in these areas may indicate a possible growth vs. value rotation or, maybe even more importantly, that the time has come again for high stock picking opportunities in the value space. Opportunity 1: Passive Investment in the Value FactorAssuming a possible value trade opportunity, will the right play be factor-driven or idiosyncratic? In other words, will this be a good time for passive investing, or active value investing, or both? To find out, we try to look at similar times in history to help guide the answer. Factor correlations implied from the risk model underscore a similar insight. The correlations between the Value and Market Sensitivity factors in 2020 are at levels not seen since the GFC. Given this, the 2008-2010 period may provide a blueprint for what may happen in value over the coming months. We see that Market Sensitivity exposure (purple) starts to rise around the time that the market was rallying going into the Lehman bankruptcy in mid-2008. The exposure rises, with some fluctuation, and hits a peak in May 2009, before subsequently falling sharply through the end of 2009 and into early 2010. The performance (blue) of the Value Spread Portfolio follows a similar pattern, rising from July 2008 through May 2009, with various fluctuations as the market reacted to the Lehman bankruptcy and ensuing government bailout packages. The market was able to squeeze out a bit more performance in value from May 2009 through Sept 2009, but by the time Market Sensitivity was already on the way down, the value performance started to taper off and did not move much in either direction by mid 2010. Opportunity 2: Stock Picking In Value StocksPerhaps there isn’t a pure passive value opportunity as the Market Sensitivity exposure starts to normalize. However, just because the pure value play is limited doesn’t mean there aren’t other opportunities for value coming up. In fact, we know anecdotally that the post-GFC period was one of the best in recent history for skilled stock pickers in the value space. It’s possible that we may be coming upon another stellar time for active investing within value. We see that idiosyncratic risk of this universe declines in the value universe going into the GFC, which is expected because correlations rise and factor effects tend to dominate in crisis periods. However, by mid-2009, idiosyncratic risk is on the rise and by the end of 2009, we were almost back at pre-GFC levels of idiosyncratic risk, as highlighted in chart above. This indicator started to fall by early 2010, indicating the high idiosyncratic risk was somewhat short-lived. Despite this, the elevated levels of idiosyncratic risk, or conversely, the low levels of factor risk, align with the notion of improved active stock picking opportunity during this time. Again, we see a major drop in idiosyncratic risk during the COVID downturn in March 2020, as correlations rose and factor risk took over. These levels bottomed out around June 2020 as the market started to readjust to the new normal and since then, idiosyncratic risk for the value universe has been on the rise. While we haven’t yet hit pre-COVID levels, this trend is very similar to what we saw coming out of the GFC. |
US & Global Market Summary
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US Market: 12/07/20 - 12/11/20
Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)
Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)
Please reach out if you’d like to understand how to align your portfolio to better benefit from the value trends we discussed or if you would like to learn more about how Omega Point can help your organization reduce risk and improve performance. |

Much Ado About Value
Alyx Flournoy, CFA
December
13,
2020