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Equity Risk Monitors — September 19, 2023

Equity Risk Monitor Highlights | Week Ended September 15, 2023

  • EM v DM update
  • Size Again?

EM v DM update

2023 started off with the ratio of Emerging Markets to Developed Markets risk well below one- where it had been stuck for all of 2022 and indicating that emerging markets were surprisingly less risky than their developed counterparts.  This was the longest period going back to 2006 where we had observed this inversion, and it concerned us to the degree that we published a white paper examining the phenomenon in detail.  Our conclusion was that the culprit was primarily the relative lack of diversification in the DM index coupled with very high volatility in the largest DM constituents.  While the lack of diversification hasn’t improved since then, the volatility of the largest names has dropped considerably year to date, and thus the Developed Markets index volatility has declined rapidly, particularly in the early spring and late summer, continuing through the first two weeks of September. The Emerging Markets index saw risk decline rapidly throughout the first five months of the year but it has climbed since then, with a bit of a tapering off in August and September.

The following chart is not published in the Equity Risk Monitors, but is available upon request:

Consequently, the EM/DM risk ratio is back around its long-term average of 1.19, largely due to the seemingly inexorably falling risk of the Developed Markets.

Size Again?

We have highlighted the Size Factor quite often in these highlights this year, with good reason.  In nearly all of our single country and regional models, the Size factor is having one of its most positive years ever:

The following table is not published in the Equity Risk Monitors, but is available upon request:

While some of these look like absolutely huge deviations relative to expectations,  it should be noted that both Japan and the Developed Markets ex-US models have small average annual values due to some very large positive and negative annual returns that cancel each other out, making the current normalized returns seem truly outsized.  For the US, the largest positive return to Size came in 1998, while in Japan the factor had its most positive year in 1997 but also had a big one in 2006, during the last pre-COVID stock market rally in Japan.  Month to date in September, the US, Canada, Europe and Japan have all shown Size factor returns that are at or above the 1 standard deviation monthly risk forecast for Size.  Of course, these could reverse course over the next 2 weeks, but the Size trend appears to be getting stronger as we come to the end of the third quarter. Investors making small cap bets should be particularly aware of the impact this will have on performance.