First things first. From all of us on the Applied Research Team at Qontigo, our very best wishes to you, our readers, for a happy and prosperous New Year with better days ahead!
To kick off 2022, we are pleased to present an expanded edition of the Weekly Highlights, which includes — among other things — key observations and takeaways for 2021. We will be covering these in even more detail in our Quarterly Equity Highlights webinar, which will take place on January 11, 2021.
Can’t make it? Register anyway to receive a link to the recording of this presentation. Details can also be found in our regional risk monitors, which are updated daily.
- Short-horizon risk fell in the first half of 2021 for most markets but rose in the fourth quarter. The increases, however, did not come close to retracing the earlier declines, so at year end risk remained well below where it started. Even with the recent uptick, the level remains just above the long-term median (since 1982) in the US. The STOXX Emerging Markets 1500 index was a notable outlier to the overall increase in fourth-quarter risk, as short-horizon risk fell early in the quarter before surging once again in December. (Exhibit 1)
- One of the major drivers of the second-half increase was sharply higher asset correlations, which reflected investor concerns about central banks, especially the Fed, tightening to combat inflation, along with increasing concerns about a COVID resurgence toward the end of the year. These higher correlations, along with higher volatility of individual stocks, meant higher factor volatility. (Exhibit 2)
- All developed-market currencies, and most emerging-market currencies, ended the year very close to their 12-month low price levels (see the Y axis on the chart below). Most were closer to their 12-month low risk levels (X axis) than to the high. CAD, CHF and JPY were exceptions, also at or near 12-month volatility highs. (Exhibit 3)
- Most factors in most regions produced full-year returns in the “expected” direction. In other words, Earnings Yield, Growth, Medium-Term Momentum, Profitability and Value returns were all positive, while Market Sensitivity, Size and Volatility produced negative returns. The same held true in the fourth quarter, when, notably, the Earnings Yield return was more than two standard deviations above the long-term average. Most other regional factors remained within a two-standard deviation boundary for the year and quarter, where standard deviation was based on the factor risk forecast at the beginning of the period. (Exhibit 4)
- The year saw some substantial changes in model style-factor correlations. For example, in our Global (WW4) model, the correlation between Volatility and Value started the year quite highly positive, but ended the year down by 0.47 points and at a level close to zero. That same substantial decrease in correlation held across most markets. These changes in correlation may have impacted portfolio active risk, so are important to track. (Exhibit 5)
- As we saw in market risk, predicted volatility of individual style factors also saw a wide range of values throughout 2021. In many regions, Medium-Term Momentum experienced the widest spread, ending the year very close to the low end of the range. The Volatility factor is noteworthy for being at or near the low end of its 12-month range in some markets (e.g. the US), but closer to the high end in others (e.g. in both Global and Emerging Markets). In some (e.g. Global) it is the most risky among the style factors, but in others (e.g. Japan), it falls in the middle of the pack. (Exhibit 6)
- Most industries in most regions ended the year at the low ends of their 12-month volatility ranges, and aggregate industry risk remained relatively stable during the year. (Exhibit 7)
- In most regions, the Information Technology sector started 2021 as the sector with the highest weight (particularly in the US and Global Developed Market indices), and with a contribution to risk that was roughly equal to that weight. By year’s end, the sector’s strength meant that its weight increased somewhat, but notably its risk rose even more. The sector is now far riskier than its weight would imply. In contrast, Financials’ contribution to risk exceeded its weight a year ago, but its risk contribution fell. In Emerging Markets, Financials’ risk is well below what its weight would suggest. (Exhibit 8)
Overall, 2021 looked like a “normal” year in terms of risks and factor returns, especially in comparison to 2020. With uncertainty about inflation and central banks actions, the continuing saga of COVID, etc., it is difficult to imagine that this “average” risk environment will continue into 2022, but one thing we can be sure about: we will continue to keep our readers informed about what we see in the data.
See charts from selected Equity Risk Monitors:
Exhibit 1. Predicted Risk
Exhibit 2. Risk Change Decompositions, STOXX Global 1800
Exhibit 3. Currency Risk and Return vs. USD
Exhibit 4. WW4 Style Factor Returns by Period
Exhibit 5. WW4 Style Factor Correlations, Current and One-Year Change
Exhibit 6. Style Factor Volatility Range (1 Year)
Exhibit 7. WW4 Industry Volatility Range (1 Year)
Exhibit 8. Sector Weights and % of Risk