Equity Risk Monitors — October 26, 2020

Equity Risk Monitor Highlights | Week Ended October 22, 2020

Europe lags in risk—and also returns; US Real Estate still in the red, despite upbeat housing data; Worldwide Profitability diverges from other style factors

Europe lags in risk—and also returns

The European equity market fell last week, amid a second wave of Covid-19 cases and fresh restrictions. European stocks have not rebounded as strongly as US and Asia Pacific stocks after the market collapse in March, and the latest set of restrictions may threaten the European market even more. The STOXX Europe 600 index fell 1% over the past five days ending Thursday, the loss remaining within one standard deviation of the risk projection at the beginning of the week, as measured by Axioma’s Developed Europe fundamental short-horizon model.

The European market is down 12% so far this year, much worse than then Asia Pacific ex-Japan market, which incurred a 6% loss, and in stark contrast to the US market, which produced an 8% gain over the same period—boosted by megacap tech companies. (See our recent blog post on how the FAANGs have contributed to US market returns: The US market can thank its FAANGs even more now — just keep an eye on risk.) At the same time, though we saw increases in risk for some European countries over the past week, Europe remained the least risky among the three regions, based on the short-horizon forecasts of Axioma’s Developed Europe (19%), Asia Pacific ex-Japan (21%) and US (20.6%) fundamental models as of Oct. 22.

See graph from the Europe Equity Risk Monitor as of 22 October 2020:

US Real Estate still in the red, despite upbeat housing data

The US Real Estate sector suffered one of the largest drops when markets tanked in March, and is now one of only three US sectors in the red for 2020. Real Estate posted a year-to-date cumulative return of negative 10% as of last Thursday, despite rising permits for new construction and surging home sales, which reached a 14-year high in September. Financials and Energy were the only other US sectors with year-to-date losses as of last week.

Real Estate represents only 3% of the STOXX USA 900 index, its weight remaining well below its value of one year ago. However, Real Estate contributed more to benchmark risk than its weight would otherwise suggest, and more than it did a year ago. Although its contribution to benchmark risk was among the lowest compared with those of other sectors in the US index, Real Estate became the second-riskiest sector after Energy, after starting the year somewhere in the middle of the pack.

See graph from the United States Equity Risk Monitor as of 22 October 2020:

Worldwide Profitability diverges from other style factors

A number of style factors in Axioma’s Worldwide model have produced outsized returns this year, which led to increased factor volatility and some big changes in factor correlations. Profitability has become considerably less correlated (or much more negatively correlated) with most other style factors in Axioma’s Worldwide medium-horizon fundamental model. The magnitude of Profitability’s correlations with Growth Leverage, Liquidity, and Medium-Term Momentum all exceeded -0.35. Profitability and Growth diverged the most, with a correlation of -0.52.

However, Profitability’s correlation with Value and Dividend Yield tightened to 0.24 and 0.16 points, respectively, from 0.02 and -0.02. The only other factors showing positive correlations (albeit of small magnitudes) with Profitability were Market Sensitivity (0.09) and Size (0.12). Investors tilting their portfolios on multiple style factors may see a big and unexpected impact on their portfolio risk due to changing factor correlations.

See graph from the Global Developed Markets Equity Risk Monitor as of 22 October 2020: