Equity Risk Monitors — July 19, 2021

Equity Risk Monitor Highlights | Week Ended July 15, 2021

  • Spread between short-horizon statistical and fundamental forecasts widens in the US
  • Sector exposures to Momentum and Market Sensitivity have changed substantially this year
  • Market Sensitivity returns have reversed course

Spread between short-horizon statistical and fundamental forecasts widens in the US

Two weeks ago, we wrote about the widening gap between the short-horizon statistical and fundamental models in Asia-Pacific. While that spread has narrowed, the gap in the forecasts for the STOXX USA 900 has grown to more than two percentage points—higher than it has been in all but a handful of days since at least 2012. As we have often noted, the statistical model occasionally picks up a transient risk that is not “seen” in the fundamental model. Further analysis shows that the stock-specific risk from each model is roughly equal, so the difference lies in factor risk. In other words, something may indeed be “bubbling under the surface.” While the two percentage-point difference may seem small, it is about 20% of the fundamental forecast of 11%. Active managers may want to examine the risk spread in their active forecasts, to see if there is an unforeseen risk there as well. Also note that there is considerably less difference in the two forecasts in the other markets we track closely.

See the graph the US Risk Monitor as of 15 July 2021:

Sector exposures to Momentum and Market Sensitivity have changed substantially this year

With Energy prices rising, Financial stocks performing better than they had been, and Market Sensitivity—which saw huge changes in exposures during the pandemic—continuing to see rotation, the exposures of certain sectors to style factors in the US have also seen some big changes. Specifically, the exposure of Consumer Discretionary to Medium-Term Momentum fell by quite a bit, while the exposures of Financials and especially Energy to that factor have jumped. At the same time, Information Technology’s exposure to Market Sensitivity popped, while a number of sectors—Financials, Industrials, Materials, Real Estate and Utilities, and again, especially Energy—saw their Market Sensitivity exposures decline. Utilities also saw an increase in Volatility exposure, as did Consumer Staples. The highlighted boxes in the table below indicate exposure changes of at least 0.5, with figures that increased in the black boxes, and figures that dropped in the red boxes. These changing factor exposures can filter into active risk forecasts, and therefore bear watching.

See the graph the US Risk Monitor as of 15 July 2021:

Market Sensitivity returns have reversed course

The theme of our Q2 2021 Quarterly Risk Highlights was “BTTON – Back to the Old Normal” (see here for more detail). The recent returns to the Market Sensitivity factor, which we touched on in last week’s Equity Highlights, are a good illustration of this. In most regions the factor’s return since March has been negative, reversing an unusually long period of highly positive returns that started with the market turnaround in April 2020. The factor’s returns in all regions except China and Emerging Markets were negative, and below the long-term average for the last one and three months. In addition, while some factors’ volatility levels remain closer to the high ends of their historical ranges, Market Sensitivity’s is right back at its long-term average.

While we chose to show the chart from the Developed Markets ex-US Risk Monitor below, the factor’s path in most developed-market countries and regions for which we have risk models looks quite similar.

See the graph the Developed Markets ex-US Risk Monitor as of 15 July 2021:

For more insights and research from the Applied Research team, please click here.