Equity Risk Monitors — November 8, 2021

Equity Risk Monitor Highlights | Week Ended November 4, 2021

  • Dispersion rises as US market hits new records
  • US small caps among the big winners
  • Asset correlations plummet in Asia Pacific ex-Japan

Dispersion rises as US market hits new records

As US indices climbed to new records, asset return dispersion rose, while the number of outperforming stocks remained low for a third straight week. US stocks rallied after the Federal Reserve announced plans to scale back its bond-buying stimulus program, but kept interest rates unchanged. While the STOXX USA 900 Index gained 2% over past week ending Thursday, only about 40% of the companies outpaced the index’s performance, meaning it was more difficult than average to beat the index. In contrast, asset return dispersion—the cross-sectional standard deviation of five-day returns—rose over the past couple of months. The widening of asset dispersion indicates that the reward to “being right” on your stock picks was higher than it has been in quite some time, although the relatively small number of names outperforming suggests that ‘being right” was more difficult.

See graphs from the United States Equity Risk Monitor as of 4 November 2021:

US small caps among the big winners

US small capitalization stocks were among the big winners last week. The Russell 2000 Index return of 4.5% over the past five business days was more than double that of its large cap counterpart index. However, the weekly return remained within one standard deviation of the expectation at the beginning of the week. US small caps’ year-to-date cumulative return of 22% is now lagging the US large cap performance by only one percentage point.

The risk of the US small caps also jumped last week, nearing 18% on Thursday—about five percentage points higher than the risk of the STOXX USA 900 Index, as measured by Axioma’s US Small Cap and US All Cap short-horizon fundamental models, respectively. In other words, US small caps are now about 29% riskier than large caps, a bit higher than the 24% relative median riskiness seen over the past two decades.

See graph from the US Small Cap Risk Monitor as of 4 November 2021:

Asset correlations plummet in Asia Pacific ex-Japan

Asian markets have been struggling lately, but asset correlations tanked in recent weeks, contributing to an overall decline in risk. The median pairwise realized 20-day asset correlation in the STOXX Asia Pacific ex-Japan Index has been falling sharply since mid-October, when it reached a year-to-date high. This low correlation environment should provide active managers with more opportunities to diversify their portfolios, since stocks are being driven by their own characteristics rather than macroeconomic events, which tend to push stocks in the same direction.

The decomposition of the change in risk from a stock-level perspective revealed that falling correlations contributed to the decline in the total risk of the STOXX Asia Pacific ex-Japan Index over the past month to a higher degree than the decline in stock volatilities, as measured by Axioma’s Asia Pacific ex-Japan fundamental short-horizon model.

See graph from the Asia Pacific ex-Japan Equity Risk Monitor as of 4 November  2021:

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