With earnings season over, the influence of fundamentals over market volatility is fading. Correlations fell during reporting season, which is normal. But even with the mass of new earnings data, macro influence over S&P volatility moved to a new cycle high in 4Q. Major macro data events/releases (Fed speakers, payrolls, CPI, etc.) will continue to exert large and outsized influence over market direction and internals.
Shifts in forces like financial conditions, real rate/yield expectations, and inflation (through pricing power) are still driving market internals for now. Over the past week, as investors priced in a higher-for-longer funds rate, the returns of 22V thematic portfolios have largely reversed. As the 4Q rally has accelerated, S&P factor returns have been more mean-reverting than any time since late 2020 (as reopening got underway). Until a clear macro narrative takes hold, more reversals should be expected.
Risk-off factors have led over the past week, reversing some of the MTD and QTD losses. Momentum has rallied as well. Style factors have shown less of a trend, which is consistent with the strong macro influence over market/factor volatility. Risk rotations remain stronger short-term drivers of factor trends. Unfortunately, those rotations are a result of unpredictable economic data and policy comments.
Beyond the current period of risk, the setup leading into 2023 is one of 1) slowing growth, 2) declining inflation/pricing power, 3) margin/earnings pressure, and 4) still elevated macro influence. At the factor level, high Earnings Turbulence is the ONLY factor that has seen increased EPS growth expectations over the past year. Focusing on Turbulence AND Growth is one way to build positions in Growth names that are well positioned for slowing economic activity while positioning for a potential risk-on reversal.
At the end of this report, we list the basket of stocks that have both high Turbulence and Realized Growth rankings.
Macro Driven Reversals: With earnings season over, the influence of fundamentals over market volatility is fading. Correlations fell during reporting season, which is normal. But even with the mass of new earnings data, macro influence over S&P volatility moved to a new cycle high in 4Q. Major macro data events/releases (Fed speakers, payrolls, CPI, etc.) will continue to exert large and outsized influence over market direction and internals.
Shifts in forces like financial conditions, real rate/yield expectations, and inflation (through pricing power) are still driving market internals for now. Over the past week, as investors priced in a higher-for-longer funds rate, the returns of 22V thematic portfolios have largely reversed. And as we noted on Monday (HERE), factor return correlations have INCREASED over the past month even as volatility and stock level correlations have declined. Macro continues to drive internals, and that is likely to remain true through at least mid-December.
Risk-off factors have led over the past week, reversing some of the MTD and QTD losses. Momentum has rallied as well. Style factors have shown less of a trend, which is consistent with the strong macro influence over market/factor volatility. Risk rotations remain stronger short-term drivers of factor trends.
Factors Becoming More Mean Reverting: As the 4Q rally has accelerated, S&P factor returns have been more mean-reverting than any time since late 2020 (as reopening got underway). Until a clear macro narrative takes hold, more reversals should be expected.
The clearest potential factor reversal trades are Momentum and Low Vol. Following the weaker-than-expected inflation print, both factors posted extreme (3-4 std) declines. Over the past week, as economic and policy uncertainty increased. Powell’s speech next and the payroll report next Friday are both potential catalysts for another near-term reversal.
Opportunity Within Earnings Turbulence: Beyond the current period of risk, the setup leading into 2023 is one of 1) slowing growth, 2) declining inflation/pricing power, 3) margin/earnings pressure, and 4) still elevated macro influence. With that backdrop, Pricing Power sentiment should be a good screening factor, and a premium should be placed on sustainable growth. At the factor level, high Earnings Turbulence is the ONLY factor that has seen increased EPS growth expectations over the past year. Growth and Momentum factors have seen declines but have MUCH stronger forward growth expectations than Value and most risk-off factors.
Higher EPS growth expectations for high Turbulence names mean they are well positioned for a slowing growth environment. High Turbulence names have also become more rank correlated with Realized Growth stocks than at any time since at least 2005.
Below is the basket of S&P stocks that have both high Earnings Turbulence and strong Realized Growth rankings. We also filtered the list so it does NOT include names with strong Value scores. A lot of Growth looks like Value these days, so it is important to explicitly remove Value when constructing Growth baskets.
