- US small cap 12-month returns turn positive after a strong week, but small caps remain risky
- Short-term asset correlations have fallen substantially, driving overall volatility down
- Factor returns reflect shift in sentiment to increased risk tolerance
US small cap 12-month returns turn positive after a strong week, but small caps remain risky
US Small Cap stocks (as measured by the Russell 2000 Index) turned in strong performance last week, outpacing their large-cap counterparts by more than two percentage points and boosting the 12-month performance over the line into positive territory. In contrast, the STOXX® USA 900 Index is still down 8.5% over the same time period. The resurgence of smaller names is another piece of evidence that equity investor sentiment is improving, and investors are seeking out riskier investments, as they have been for much of this year. And US stocks, both small and large, are riskier than their counterparts around the globe. In addition, risk has fallen just 50 basis points (or a proportional 2%) since the end of 2022 in US small cap, as compared with an 8% proportional decline in US large caps.
See graphs from the Equity Risk Monitor of 3 February 2023:
Short-term asset correlations have fallen substantially, driving overall volatility down
The average 20-day and 60-day rolling realized correlations of stocks have dropped significantly since the end of last year, and in many regions are currently well below their levels of a year ago. Although these are not the weighted correlations based on a longer horizon used in the risk models, they are related, and can help provide context for some of our observations about risk and what is driving its changes.
One such chart is the one showing the decomposition of the change in risk over the past week, month, 3 months, 6 months and one year. We not only look at how the factor model is driving changes, we also look at what would happen if we used a dense, asset-asset matrix. The decomposition of the change in risk for the STOXX® Global 1800 shows the importance of asset correlations in driving risk down over recent periods. In fact, lower correlations were a bigger driver of the change than lower individual stock volatility for the past week and month, and had equal impact for the past three months. These asset correlation changes may have had similar impacts on active risk as well.
See graphs from the Global Developed Markets Equity Risk Monitor as of 3 February 2023:
Factor returns reflect shift in sentiment to increased risk tolerance
The shift to a more risk-tolerant stance and consequent rotation into riskier names in also reflected in style factor performance. After producing highly negative returns in 2022, both Market Sensitivity and Volatility have shifted course, and returns have been quite positive across regions, especially for Market Sensitivity. Evidence of a shift in sentiment had already shown up in Medium-Term Momentum during last year’s fourth quarter. The factor’s fortunes have continued to be negative this year as well, with returns more than two standard deviations below the long-term average in the US, Canada and the Worldwide model. Momentum’s return in other regions has not quite breached the barrier beyond which we consider returns to be “outsized”, but it has been quite negative nonetheless. Also of note is that Profitability’s return has been very region dependent. It has fared quite well in the US, and Australia, but the return has been negative in Canada and Emerging Markets.
See graphs from the Global Developed Markets Equity Risk Monitor as of 3 February 2023:
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