Since the market peak in March, Value has dominated market internals followed closely by Low Volatility gains. Overall, Value factors have rallied 8.4% (l-s) while the SP has fallen nearly -14%. A relief rally as economic growth slows could help lift equities, but with implied volatility indicating 2% average daily S&P moves for the next four months, and investors still debating if the Fed will need to force a recession to slow inflation, directional market positioning will be difficult for the next few months.
The extreme increase in real yields (97th %tile) appears to have driven MOST market internals. Factors most positively correlated to changes in real yields tended to outperform over the past month, with Value factors the biggest winners and Growth the biggest loser. The gain by Realized Value over the past month is a 99th %tile move.
Value’s gains relative to Growth have been extreme, particularly given the downturn in leading indicators. And as we noted last week, the rank correlation between the Value and Growth (overlap of Value and Growth rankings) is high. Elevated rank correlations suggest there should be LESS return divergence between the two factors.
As we have detailed this year, factor rotations have been frequent and driven by micro trends (here). Inflation fears appear to be easing some and growth readings are slowing some, which should take upward pressure off real yields near-term, reducing the tailwind for Value.
Near the end of this report, we list the names with the highest Realized Value exposure and low Realized Growth names (Shorts/underperformers). If real yields stabilize, names with high exposure to Value and low exposure to Growth will face more downward pressure.
One last point. Over the past month, most factor returns followed the path of real yields, but investors also considered the remarkable tightening of financial conditions (95th %tile). Low Volatility, a factor most highly correlated with tighter financial conditions and slower growth, surged during the market decline. If real yields are topping a financial condition tightening eases some, Low Vol names will be at risk of a declining near-term.
Yields Driving Market Internals: Since the market peak in March, Value has dominated market internals followed closely by Low Volatility gains. Overall, Value factors have rallied 8.4% (l-s) while the SP has fallen nearly -14%. The gain by Realized Value over the past month is a 99th %tile move. Rapid mean reversion has been the norm in 2022 and we expect that to continue until the path of inflation/growth becomes clearer. That spell trouble for Value near term.
A relief rally as economic growth slows could help lift equities, but with implied volatility indicating 2% average daily S&P moves for the next four months, and investors still debating if the Fed will need to force a recession to slow inflation, directional market positioning will be difficult for the next few months.
The extreme increase in real yields (97th %tile) appears to have driven MOST market internals. Factors most positively correlated to changes in real yields tended to outperform over the past month, with Value factors the biggest winners and Growth the biggest loser. Inflation fears appear to be easing some and growth readings are slowing some, which should take upward pressure off real yields near-term, reducing the tailwind for Value. Longer-term, a backdrop of higher inflation and slowing but NOT crashing growth, supports indebted companies with fixed debt costs. That backdrop would be a consistent support for a segment of Value names.
Value’s gains relative to Growth have been extreme, particularly given the downturn in leading indicators.
And as we noted last week, the rank correlation between the Value and Growth (overlap of Value and Growth rankings) is high. Elevated rank correlations suggest there should be LESS return divergence between the two factors. Declining economic activity and peaking real yields (at least short-term) is a headwind for Value names.
Below we list the names with the highest Realized Value exposure and low Realized Growth names (Shorts/underperformers). If real yields stabilize, names with high exposure to Value and low exposure to Growth will face more downward pressure.
Comment on Rotations: As we have detailed this year, factor rotations have been frequent and driven by micro trends (here). Over the past month, most factor returns followed the path of real yields, but investors also considered the remarkable tightening of financial conditions (95th %tile). Low Volatility, a factor most highly correlated with tighter financial conditions and slower growth, surged during the market decline. If real yields are topping a financial condition tightening eases some, Low Vol names will be at risk a declining near-term.
