Your Exposure to the New Economic Order

Russia’s invasion of Ukraine has transformed the world in an instant. 1.5 million people have already fled the country, and a 40-mile-long Russian convoy amasses on the outskirts of Kyiv. The humanitarian costs continue to stagger, and our hearts go out to the people of Ukraine. The third round of talks about ending hostilities is planned for this Monday; we can only hope that a cease-fire finally holds and more casualties are avoided.

In an attempt to end the conflict without igniting the next world war, the EU and a growing number of global powers have launched an all-out economic war to squeeze Russia by de-coupling it from the world’s economy. Last week, we interpreted the impact of the newly emerged crisis on the broader financial markets. This week, we continue to leverage the Omega Point platform to help investors better measure their own exposures and position portfolios to fit this new world economic order.

With Russia decoupling from the world’s economy, investors are left with a key question: how do I measure my exposure to this new world economic order?

On Feb 23, 2022, an investor looking at the historical sensitivity (Beta) of the Russian stock market benchmark to the global market (e.g., ACWI) would have concluded that for every 1% move in the global markets, Russia would have moved 0.9%...

Between Feb 24 and last Friday, Russia’s stock market massively decoupled from the global markets...

Any investor looking to assess their portfolio’s risk to the Russia / Ukraine crisis clearly cannot utilize historical correlations of Russian stocks to their securities.

“Surprise” Characteristics Help Define The New Economic Order

Last week’s Factor Spotlight leveraged our access to over 150 style and 400 sector characteristics to measure the market reaction to the invasion on Feb 24, 2022. In addition, we utilized a surprise metric: namely, a factor’s move (return) divided by its predicted move (standard deviation). Factors with considerable surprise moved far more than their predicted daily move (>2 Std Dev) and demonstrate the market’s reaction to the new information coming from the Russia/Ukraine crisis.

As the market continued to absorb information in the past week, we’ve continued to update the surprise metric for each factor by measuring its move cumulatively since Feb 24 relative to its predicted movement over the same period. Below we see the key Surprise Style and Sectors, some of which demonstrated > 3, or even > 4, standard deviation moves over the week.

Positive Style surprise characteristics: Global Exporters, Commodity/Oil, and Profitability

As oil prices reacted to the West’s economic sanctions and Russia’s response, we saw significant surprise in the Oil & Commodity factors. In addition, we continue to see strong performance from both US and Global exporters (exchange rate-sensitive companies) as they presumably will be replacing Russia’s exports in the new economic order. Finally, the surprise in Short Interest likely underlies the short covering of thematic shorts before the invasion (tech, healthcare).

Negative Style surprise characteristics: Value, Carbon, Hedge Fund Crowding

Value factors continue to be negatively associated with this crisis, likely due to an expectation that central banks will temper the rise of interest rates. In addition, the lack of demand for carbon emissions in the short term is related to the lack of oil supply, and the selloff in hedge fund crowding highlights an unwinding of crowded thematic hedge fund trades.

Positive GICS Sector & Region Surprise Characteristics: Energy Industrial Complex, Defense, Utilities, & Telcos

Investors' expectations of global commodity shortages - coupled with increased defense spending - have propped up Energy, Industrials, and Materials industries levered to oil & defense spending. In addition, telcos are historically a defensive investment, and major media outlets stand to gain users & advertising from increased coverage of the crisis.

The surprise metric on Utilities is highly region-dependent, as you will see below in the negative characteristics table.

Negative GICS Sector & Region Surprise Characteristics: Financials, Raw Materials & Parts Importers, & Airlines

Raw materials & oil price shortages/hikes will lead to cost increases in the supply chain, many of which will not be passed on to consumers. US utilities, auto components, food & beverages, and tech hardware are likely hit due to these issues. In addition, airlines face a double whammy due to increased fuel prices and reduced travel demand.

Financials are expected to underperform from lower rates and disruption to the SWIFT transfer system.

Omega Point’s Surprise Characteristics Index

Dynamically staying on top of all the above surprise characteristics is tremendously challenging. We've built a Surprise Characteristics Index to streamline this task, which combines the above characteristics into a single factor index, allowing investors to measure their sensitivity (e.g., beta) to this index. A positive/high beta suggests that the investor's portfolio is positioned well with the changing global economic order. In contrast, a negative / low beta indicates that the investor's portfolio is positioned poorly with the changing global economic order.

We will be unveiling the Surprise Characteristics Index in next week's Factor Spotlight, alongside various analyses showing how it positions to known market indexes & ETFs. So please reach out to us if you'd like a sneak preview of your portfolio ahead of next week's post.

As we’ve seen over the past week, the distressing situation in Ukraine remains highly volatile, with new developments coming in by the minute. We stay glued to our newsfeeds in the meantime and only wish that this crisis ends soon, peace comes to the people of Ukraine, and we can resume Factor Spotlight coverage in other, just as timely, directions.

US & Global Market Summary

US Market: 02/28/22 - 03/04/22

• The Dow fell 200 points on Friday, capping another turbulent week as Russia expanded its war in Ukraine. The Dow dropped 1.3% for the week, while the S&P 500 and Nasdaq fell 1.3% and 2.8%, respectively.
• Shares of banks and financial-services companies fell hard, while energy companies saw significant gains.
• The benchmark 10-year U.S. Treasury note yield slid to 1.72%, its biggest weekly yield decline since Mar 2020.
• Front-month futures prices for Brent crude oil rose 25% to close at the highest level since 2013.
• The Russian ruble lost 26% vs. the USD, its worst week since 1998, while the NYSE halted trading in several Russia-linked ETFs, and index providers moved to drop Russian stocks from their indices.
• And one sliver of positive economic news: new data showed that the U.S. added 678k jobs in February, more than the 440k expected by economists.

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

• Growth and Medium-Term Momentum remain on an upward tear switching up last week’s 1-2 spots as they approach the overbought threshold in tandem.
• Market Sensitivity (beta) stalled following several weeks of upward pop and remains at 1.74 SD above the mean.
• Earnings Yield continued to slide and crossed into oversold territory.
• Size’s recent hints of weakness were affirmed as a plummet this week sent it crashing through the oversold threshold.
• Value continues its downward spiral crossing into negative terrain to secure the bottom spot for another week.
• U.S. Total Risk fell 0.22% this week.

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

• Global Growth and Medium-Term Momentum, in sync with the U.S., switch up last week’s 1-2 spots and build further on recent strength.
• Profitability softened its explosive rise of late but continues to show strength as it nears positive territory.
• Earnings Yield sputtered 1 BP downward, but still fell for a tenth consecutive week.
• Exchange Rate Sensitivity slid once more on the tails of its scorching climb extinguished just three weeks prior.
• Market Sensitivity (beta) fell for the first time in 10 weeks and officially exits overbought terrain, for now.
• Size dropped like a rock following signs last week of a slow-down.
• Value finishes dead last for a 4th straight week and finally crosses into the negative column.
• Global Total Risk fell 0.31% this week.

Regards,
Omer