After a tumultuous four-day trading week, we wanted to quickly check in on some factors that we've been tracking, and then examine why Profitability is being flagged as “Extremely Oversold,” and compare the current period to previous times of weakness for that factor.
This week saw another broad equity market selloff with the US market factor (99% correlated to the S&P500) down 1.35%, with the majority of the move occurring on Dec 4th.
Here's a brief summary of how Omega Point's normalized return indicator changed over the past week for some key factors. Note that no major factor saw a substantial move relative to trend, indicating that the market selloff was not particularly related to any one factor.
On a cumulative basis, two factors of note were Market Sensitivity (-87bps) and Medium Term Momentum (+58bps). We'll continue to monitor factor movement next week for anything noteworthy.
Our Factor Profile tool is currently flagging Profitability as “Extremely Oversold” at -2.67 standard deviations below the mean:
As we can see, this factor has high positive risk premia, and thus typically enjoys a strong upward trajectory. Lately, we can see cumulative returns have fallen since a recent peak on 10/30, which explains why the factor's looking so weak on a normalized basis.
Weakness in Profitability may suggest that the large long-only funds and other firms that buy big chunks of high-quality companies are still mostly on the sidelines of the equity market.
If we take a look at a couple of historical instances when Profitability hit a bottom, we can get an idea of how oversold this factor is at the moment.
During the “Factormageddon” of Jan 2016, the market took a hard downturn.
US Market: 1/1/15 - 12/30/16
During that same period, we can observe a flight to quality, resulting in a big rally for Profitability:
Profitability (Cumulative): 1/1/15 - 12/30/16
Eventually, returns for the factor started to become less torrid, causing normalized returns to plummet after hitting a 2/11/16 peak of +3.29 SD above the mean.
Profitability (Normalized): 1/1/15 - 12/30/16
At -2.67 SD below the mean, Profitability is now more oversold on a normalized basis than it was during the Jan 2016 trough of -2.26 SD below the mean.
Global Financial Crisis
Looking at the period between 2008 - 2010, we can see a similar trend:
US Market: 1/1/08 - 12/30/10
Profitability (Cumulative): 1/1/08 - 12/30/10
Profitability (Normalized): 1/1/08 - 12/30/10
These are two other instances (Jan 2009 and Aug 2010) when a flight to safety resulted in a Profitability rally, and then normalized returns fell as the factor couldn't keep up the same pace indefinitely. Each time, upon hitting a bottom, the factor would see a quick reversion to the mean.
Taking a look at the most recent market downturn, we can see this theme play out again. A rally in profitability has given way to weakness, resulting in a plummet in normalized return.
US Market (12/6/17 - 12/6/18)
Profitability (12/6/17 - 12/6/18)
From this historical perspective, it certainly feels like this factor is getting close to a bottom and has a high likelihood of a rally in the near term. In each of these previous instances, we can see how steeply the factor typically bounces back from trough. With that in mind - if your portfolio happens to be underweight Profitability, we recommend keeping an eye on it and perhaps taking caution.
If you'd like to see what your exposure is to Profitability (or any other factor), or would like to learn the actions you can take to shield your portfolio from big factor movements, please don't hesitate to reach out.