By Philip Lawlor, managing director, head of global markets research
Equity factors made a dramatic U-turn in September, capturing the mercurial and rapidly shifting appraisal of economic prospects across global markets. But we think it’s too early to call this a regime change.
As the chart below shows, Value (and less so) Size factors snapped long-running losing streaks across most markets in September, while long-popular defensive Quality and Low Volatility factors retreated.
The September rotation came amid synchronous central-bank stimulus efforts and renewed global trade optimism, which helped alleviate the deep pessimism about the global economy that had sent equity markets and government bond yields sharply lower in August. As risk appetite improved and this summer’s bond rally eased, investors gravitated to undervalued, economically sensitive stocks, rather than stick with the more defensive, counter-cyclical (and expensive) stocks that had been outperforming for most of the past year. Chart 2 shows the near lockstep relationship between US Value and swings in US 10-year Treasury yields.
Defensive stronghold remains intact
By month-end, however, the risk rotation had lost vigor. Worsening leading economic indicators and noncommittal Fed comments about future rate cuts reignited doubts about global growth, and bond yields headed south again. Despite their September setback, Quality and Low Volatility retained their leadership across most markets for the year so far (Chart 3).
Interestingly, emerging-market (EM) factor trends diverged markedly from those of their developed peers. The Value and Size rallies were much more muted in EM. Moreover, EM Quality and Profitability surged in September, with the former ranking by far as the strongest performer among all global factors for the year.
Traditional value sectors take center stage
So, what does the September rotation tell us? Much of the Value recovery can be traced to the factor’s sector concentrations.
As the left-hand Chart below shows, in most markets, Value is significantly overweight financial and oil stocks, which strongly outperformed in September (Chart 4, right hand side). Financials benefited from the rebound in bond yields from multiyear lows in August and diminishing global growth worries, both positives for sector profitability. Oil stocks rose amid rising commodity prices. Value’s relative performance was also helped by its large underweights in health care and technology, which generally lagged for the month.
US Treasury yields call the shots
The September rotation also reflected sensitivities to shifts in macroeconomic trends, most specifically to moves in US Treasury bond yields. As Chart 5 illustrates, Value and Size have exhibited strong positive correlations to 10-year US Treasury yields over the past year, especially in the US, UK and Europe.
At the same time, Momentum, Low Volatility and Quality have been moving in the opposite direction as US bond yields. Interestingly, Quality and Profitability in Japan and Asia Pacific have shown far less sensitivity to shifts in US Treasury yields than its global peers.
We also found that factor sensitivities to macro shifts are far more subdued in EM than in developed markets. Also, unlike elsewhere, correlations between EM Profitability and Quality and shifts in US Treasury yields have gone from negative to positive, while the positive correlation between EM Value and 10-year US Treasury yields has diminished over the past year.
Our research also found that these correlations have grown significantly stronger across developed markets over the past two years.
By dissecting the major sector and macroeconomic drivers that underpin factor performance, factor analysis can offer investors valuable insights that can help clarify market behavior and inform their investment decision-making.
For more detail on factor trends, join our webinar.
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