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Equity Risk Monitors — January 25, 2021

Equity Risk Monitor Highlights | Week Ended January 21, 2021

Country volatilities ease, despite surging pandemic; Asset correlations drop to 12-month low, driving down risk; Is the sector rotation over?

Country volatilities ease, despite surging pandemic

The latest chart of global volatility hotspots revealed sharp decreases in volatility over the last week at the individual country level (from the USD perspective). Volatilities, as measured by Axioma’s Worldwide short-horizon fundamental model, decreased by more than one percentage point in numerous countries around the globe, particularly in Europe. The reduction in volatility occurred despite renewed outbreaks of coronavirus cases around the world. Investors seemed to be encouraged by government and central bank efforts to support their economies. The STOXX Global Total Market index saw an aggregate decline in risk of almost 100 basis points over the past five business days.

See graph from the Equity Risk Monitors as of 21 January  2021:

Global Volatility Hotspots Volatility measured by AXWW4-SH Model

Asset correlations drop to a 12-month low, driving down risk

After rising to a near-term peak in November, asset correlations worldwide have dropped, reaching a 12-month low in January, as markets continued to rise in 2021 and investors sorted through their expected winners and losers. The median pairwise realized 20-day correlation in the STOXX Global 1800 index jumped almost six-fold from January to March 2020, nearing 0.60 by March. Since the market bottomed out, however, asset correlations have followed a generally downward track, although there were some bumps in the road around July and November.

The median 20-day correlation dipped below 0.10 in January. While the 60-day median pairwise asset correlation has also fallen since March, it has remained relatively flat in recent months, but will likely follow in the footsteps of its shorter-term counterpart in a few weeks. Lower asset correlations typically indicate that companies’ individual characteristics are driving stock prices, rather than concerns about macroeconomic events, and have been an important driver of the overall decrease in predicted risk.

See graph from the Global Developed Markets Equity Risk Monitoras of 21 January  2021:

STOXX Global 1800 Rolling Average Asset Correlations

Is the sector rotation over?

Information Technology and Consumer Discretionary (where Amazon is dominant) saw strong returns, while Energy and Financials lost ground last week, begging the question: is the sector rotation seen in the fourth quarter over? Sectors’ fortunes turned in the middle of the fourth quarter (Q4), on news of COVID vaccines and hopes of a return to normalcy. Both Energy and Financials saw sharp turnarounds resulting in strong gains for Q4, although both sectors posted negative returns for 2020. In contrast, Info Tech and Consumer Discretionary recorded relatively small gains in Q4, but were the best performers of last year, among the 11 GICS sectors in the STOXX USA 900 index. For more details on sector performance in the fourth quarter and in 2020, please see Qontigo Applied Research Q4 2020 Insight Report – A Turbulent End to a Haywire Year.

Despite last week’s losses, Energy recorded the highest year-to-date cumulative gain (12%), followed by Consumer Discretionary (6%), which replaced Financials (4%) as the second-best performer in 2021. Info Tech’s year-to-date return (3%) was in the middle of the pack.

Consumer Discretionary and Info Tech were the second- and third-riskiest sectors after Energy, respectively, while Financials was in fifth place at the end of last week, as measured by Axioma’s US medium-horizon fundamental model. However, Info Tech had the highest contribution to STOXX USA 900 risk—about 30%, which was higher than its weight in the index. Consumer Discretionary also saw a higher contribution to benchmark risk than its weight would otherwise suggest but, in contrast to Info Tech, Consumer Discretionary’s contribution was much higher last week than its level of 12 months ago.

See graph from the United States Equity Risk Monitor as of 21 January  2021:

STOXX USA 900 Sector Weights and Percentage of Risk