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Equity Risk Monitors — November 28, 2022

Equity Risk Monitor Highlights | Week Ended November 25, 2022

  • US stock prices and risk both rise, defying their typical inverse relationship
  • Developed Market currency risk has surged in November
  • Magnitude of Emerging Markets and Developed Asia ex-Japan style factor returns is higher than expected

US stock prices and risk both rise, defying their typical inverse relationship

The US market, as defined by the STOXX® USA 900, has gained about 11% since the end of September, while at the same time the risk forecast from the Axioma US4 fundamental short-horizon model has also risen about 11% over the same time period. Looking back over the 40-year history of our US model, we find that it has been more likely for risk to fall when the market rises over rolling two-month periods.

We attribute the long-term negative correlation between market returns and changes in risk to the usually slow ratcheting up of stock prices in contrast to the large and sudden downward moves that are more likely. However, because Qontigo’s equity risk models use more history than just two months of returns, we also recognize that what has happened earlier will also impact the current risk forecast, and that is what we observe currently. Earlier this year, the US market saw many big swings in daily returns and a generally downward trend. We believe that explains the somewhat unusual pairing of higher returns and higher risk we have seen recently.

See graph from the US Equity Risk Monitor of 25 November 2022:

Developed Market currency risk has surged in November

Developed Markets currency risk based in US dollars has been steadily rising since March 2022, as the war in Ukraine drove investors away from other currencies into the dollar, but has surged an additional 20% in November, pushing the increase over the recent bottom in March to 68%. The sharp increase in currency risk has been driven not only by higher volatility in all major developed market currencies (which are all at the high end of their 12-month range), but also by higher correlations between them. Investors making currency bets, especially dollar-based investors, may want to take note of the sudden surge in currency risk and recalibrate their positions if that risk has gotten too high.

See graphs from the Global Developed Markets Equity Risk Monitor of 25 November 2022:

The following chart is not available in the Equity Risk Monitors, but appears in the quarterly Insight report and is available on request:

Magnitude of Emerging Markets and Developed Asia ex-Japan factor returns is higher than expected

Factor returns have been largely “well-behaved” over the past month, meaning they have remained within a two-standard-deviation band around their long-term averages (even if they have moved in an unexpected direction, notably the negative return to Medium-Term Momentum in many markets). In Developed Asia ex-Japan and Emerging Markets that has not been the case, however.

The following table highlights one-month factor returns in both regions, with those factors whose returns fell outside of the two standard deviation band highlighted in green. (Momentum’s returns were well below average, whereas Market Sensitivity has a negative return on average, and therefore they are highlighted in a different color). Clearly quite a few factors’ returns were larger than expected, and investors may want to take note as they calculate performance attribution.

In most other regions there were no factors or just one with outsized returns; the Worldwide model saw unusually positive returns to Liquidity and Profitability. While exposure to many of these factors may not lead to the highest returns among all the style factors, they are high relative to their own history and thus bear acknowledging.

See graph from the Emerging Markets Equity Risk Monitor of 25 November 2022: