By Philip Lawlor, head of Global Investment Research
Equity factor performance has been riding a risk-on/risk-off rollercoaster in recent months. Though risk appetite has revived since the March meltdown, an undercurrent of defensiveness persists.
Spirits ran high in May as economies began to reopen and signs of recovery emerged. Markets staged a strong rotation into long-battered smaller cap (Size) stocks for the month, mostly at the expense of Low Volatility and Momentum.
But the risk rally hit a speed bump in June, as a fresh flare-up in coronavirus cases undermined hopes for a quick comeback in economic activity. Size outperformance waned, and Quality and Profitability resumed their winning streaks. Low Vol, however, remained in the doldrums.
Second-quarter 2020 regional factor returns relative to home markets (local currency %)
Source: FTSE Russell. Data as of June 30, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
Longer-term views of global Size and Quality factor performances, shown below, best illustrate the give-and-take in risk appetite this year.
Size was the chief beneficiary of the post-lockdown economic optimism, as captured in its large overweights in rebounding financials and other cyclically sensitive stocks in May. Even so, Size remains a major laggard in most markets this year and for the past 12 months, particularly in the US and emerging markets.
Notably, UK Size has almost fully recovered from its steep pullback in March and remains the factor’s sole outperformer globally. Sector exposures explain this divergence: versus its global peers, UK Size is more heavily weighted to the industrials and consumer services sectors, which outperformed in Q2, and far less exposed to lagging oil stocks.
Regional Size returns relative to home markets (rebased, local currency %)
Source: FTSE Russell. Data through June 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Despite the Q2 risk-rally headwinds, Quality continued to build on its long-standing leadership in most markets. The factor has even gained favor in the UK, where it has languished until recently.
The factor’s YTD strength is the outgrowth of its large overweights in outperforming technology and health care stocks, which outperformed in most markets in both the Q2 and for the year so far. Quality is also significantly underweight financials, which have continued to badly underperformed for the year so far despite a Q2 rebound.
Regional Quality returns relative to home markets (rebased, local currency %)
Source: FTSE Russell. Data through June 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Healthy balance sheets retain their appeal
More important, Quality has greatly benefited from the persistent investor preference for the stocks of financially healthy companies.
When we isolated the drivers of global Quality performance, we found that measures of balance-sheet strength, such as high asset turnover and low accruals, and of low leverage (see chart below) have outperformed in most markets this year. As we see it, investors still desire the safety of stocks with the financial wherewithal to maneuver through the uncertain economic terrain ahead, even as they venture into riskier territory.
(Low) Leverage component returns relative to home market – YTD 2020
Source: FTSE Russell. Data as of June 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Global equity markets have climbed a wall of worry over the past several months and are likely to remain captive to the unfolding developments on the health and policy fronts, feeding further volatility in factor performance in the months ahead.
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