Continue active refreshing of this index's data?

Continue active refreshing of this index's data?

Equity Risk Monitors — November 7, 2023

Equity Risk Monitor Highlights | Week Ended November 3, 2023

  • Short-horizon predicted risk rose substantially last week, and now exceeds medium-horizon
  • Outsized style factor returns and US factor reversal last week
  • Return dispersion is back up

Short-horizon predicted risk rose substantially last week, and now exceeds medium-horizon

Despite – or maybe because of – last week’s relief rally, short-horizon risk rose substantially last week in the US. The US market was unusually strong, with returns exceeding 1% on four of the last five days, propelled by good economic news and falling bond yields. Whereas upward-moving markets are more typically associated with a decline in risk, the magnitude of the returns combined with the uptick in realized volatility in recent weeks meant higher, not lower risk this time around.

Predicted risk was also up in Developed Markets ex-US, Emerging Markets, Europe, Japan and others, but the biggest increase among the benchmarks we track closely was in the STOXX® US Index. Risk has also risen substantially from the low levels we observed in mid-September, with the STOXX US forecast about 40% higher and Developed Markets ex-US almost 25% more. And while US expected volatility remains substantially lower than where it stood a year ago, it now exceeds the long-term median level for the first time since June.

During the past week the short-horizon fundamental US risk forecast also exceeded its medium-horizon counterpart for the first time since last January. This positive spread between the two horizons started a week or two earlier in a number of other markets. The spread suggests that the medium-horizon risk projection is likely to rise as well, so managers using the medium horizon in their portfolio construction should be aware that active risk may rise as well. We do note, however, that the risk forecast coming from the trading horizon model, which is by definition more reactive to the recent past, declined by more than five percentage points over the week, so it will remain to be seen how long the short-medium horizon spread continues to be positive.

See graphs from the STOXX World US and STOXX Developed Markets ex-US Equity Risk Monitors of 3 November 2023:

Outsized style factor returns and US factor reversal last week

Investors once again sought high beta last week across all major markets. The return to the Market Sensitivity factor was positive ranging from a low of 0.34% in China to a high of 2.80% in US Small Cap, among Axioma’s fundamental medium-horizon regional models. Most of these returns (in US all-cap and small cap, UK, Europe, Developed Markets ex-US and Worldwide models), were two to three standard deviations higher than the (negative) average five-day return, where the standard deviation is defined as the predicted factor volatility at the beginning of the week. Similarly, the Volatility factor (which also has a negative expected return)( had positive returns across all markets the Risk Monitors track closely, with a return exceeding the two standard deviation threshold in the Canada, Europe, Developed ex-US and Worldwide models. In most of those markets Value also had an unusually good week, although the return was negative in Australia and China.
Other style factor weekly returns exceeding the threshold include a negative return to Exchange Rate Sensitivity in Canada and a positive return in UK and Japan. Returns to Medium-Term Momentum were largely negative (except in Canada and China), but within the expected range.

At the same time, some US factors staged a reversal in weekly returns. Notably, the high Market Sensitivity return last week followed a very negative return in the prior week. Value also substantially reversed course from negative to positive weekly returns, whereas Momentum and Earnings Yield were positive the prior week and negative last week. It is too early to tell whether these reversals will persist, but we will be sure to keep an eye on them.

The following charts do not appear in the risk monitors, but are available on request:

Return dispersion is back up

Volatility has been muted for quite a while now, and despite the relatively low level of asset-asset correlations, dispersion has remained low. (Dispersion, in this case the cross-sectional standard deviation of five-day returns, is a function of both – the higher the volatility the higher the dispersion, and the lower the correlation the higher the dispersion.) Over the last week, dispersion jumped to a level last seen during the banking crisis earlier this year. The recent increase in dispersion can be observed in most markets we track closely, with Europe (as measured by the STOXX Europe 600), a major exception.
High dispersion theoretically means better opportunity, especially for good stock pickers, as the reward to being right is higher than when dispersion is low. For factor investors, however, our work has shown that factors tend to have roughly the same level of performance whether dispersion is high or low. Please contact your Axioma representative for more information on that topic.

See graph from the STOXX Developed World Equity Risk Monitor of 3 November 2023: