Value and Risk-on factors continued to gain after the dovish FOMC meeting this week and have been the best performing factors in March. Value’s rebound has supported the overall improvement in the GARP basket, and the portfolio sharply rebounded in March as well. With Powell reducing concerns about possible FCI tightening, Value and risk-on outperformance should continue to catch up to macro fundamentals. The next bug challenges to those trends are payrolls on April 5th and inflation on April 10th.
At the industry group level, the sensitivity of fundamental factors has increased relative to risk factors in March. Cyclical industry groups, in particular, have become more tied to value/Growth exposures. Value, Risk-on and Momentum factors YTD return significantly diverged from their sensitivity to yield curve and yields. Some catch up of Value and Risk-on factors along with drop from Momentum of Price is needed to narrow the divergence.
In addition to factor return and sensitivity, it is important to strip alpha from beta and observe the active returns generated by factors. Both large cap and mid/small cap names have seen declining active returns from Momentum factors in March relative to late-February. Value active returns have rebounded across caps breakdowns, and Risk-on has rebounded in mid/small caps. Those shifts are consistent with our expectations (HERE). At the end of the report, we list the S&P names that have relatively high exposure to Value and Risk-on factors and should benefit from the factor gain near term.
Value & Risk-on Influence Growing: The dovish Fed meeting this week further encouraged the rotation into Value and Risk-on factors that have been gaining steam over the past several weeks. Realized Value was the second worst performing factor in February and is the second best performer in March. The Value rebound has supported the GARP basket, which sharply rebounded in March. Near term, the Value and risk-on outperformances are likely to continue until the next payroll April 5th and inflation April 10th.
Factor returns and sensitivities indicate investors are increasingly focusing on fundamentals over risk. When looking into factor sensitivity by the S&P industry groups over the past few weeks, Realized Growth and Realized Value sensitivities were positive for 75% and 55% of the industry groups respectively. That is especially true for Cyclicals. While both Risk-on and Risk-off factors sensitivities have fallen across most industry groups.
In addition to factor return and sensitivities, it is important to strip alpha from beta and observe the active returns generated by factors within each index. For the S&P 500 names, excluding mega-cap names (which had diverged from volatility trends of other segments, HERE), Value factor active returns have improved relative to February at the expense of Momentum and Quality names.
Momentum factors active return within mid and small cap names also dropped in March relative to late February. Risk-on factors active return rebound and contributed to mid and small cap returns MTD. Unlike large-cap names, Value factors had better active returns in the late half of February within mid and small-cap names, and the trend continued into March.
We expect those trends to continue because of macro support. As we discussed in early March (HERE), Value and Risk-on factors have the highest sensitivity to yield curves and yields, but their returns have lagged the yield curve recovery this year. Price Mo, on the other hand, has significantly outperformed relative to yields and has become tied to the Size/Quality factors that led internals over the past ~year. Recently we have seen factor reversal with Value and Risk-on factors catching up with yields, especially for Earnings Turbulence whose YTD return is now positive. Value return should be expected to rebound positive as well as negative yield curve normalized.
Below we list the S&P names with both relatively high Value and Risk-on exposure and should benefit from their factor exposure near term.
