The factor landscape YTD after the sell off
The market had been whistling past the graveyard as
Armageddon swept across China. We said last week that, “with Covid-19 rapidly
spreading across Italy this weekend not to mention the series of infections in
Japan & Korea, markets are likely to remain under pressure” before the
swiftest six-day correction in the history of US markets. It’s
no surprise that China’s draconian quarantining measures have led to an
unprecedented crash in both the manufacturing and non-manufacturing PMIs there
(February). However, with Covid 19 already in 65 countries & the 1st
confirmed case just reported in NYC not to mention 6 deaths in WA state, it’s
clear that all such measures might not contain this contagion (literally &
figuratively). The fact is that it’s likely to spread just like the common
cold/ flu across the world eventually exposing everyone since the transmission
is airborne. Down the road it may become a permanent seasonal fixture along
with the various strains of influenza that we inoculate against each flu season
once there is a vaccine. Not enough is known about the disease propagation
yet but we do know that the Ro (2-2.4 transmission rate) is high (https://www.facebook.com/teppercmu/videos/223086638736293/
The seven day (20th Feb – 28th Feb) -13% haircut to the SPX qualifies as the fastest correction in history. However, it was an orderly decline without the usual histrionics caused by liquidity holes, flash crashes, margin calls and systemic outages a la 2008 (those are likely still to come like the Robinhood outages). As anticipated by the Fed fund futures market we got the 50bps emergency rate cut by the Fed today. We expect global coordinated rate cuts to follow even though with so many rates in negative territory, central bankers are mostly out of ammunition unless they resort to non-traditional monetary stimulus. While timely, these measures cannot revive patients or economic activity unless we get past the curtailment of public activities, travel & quarantining once there’s a realization that the spread can be slowed but not easily stopped. Demand destruction of this nature cannot be fixed by rate cuts nor can it restore the supply chain disruptions. That realization alone could bring the buy every dip mentality to a halt. Indeed, the markets negative reaction to the cuts intraday would suggest that the Fed may have wasted precious little ammunition left (caving into political pressure) while this Administration squanders every opportunity towards constructive preparedness down in the trenches.
It remains to be seen if this movie has a macabre ending like that of the Spanish Flu of 1918 or a more benign denouement like that of SARS which died out once the virus mutated & people distanced themselves from civet cats – the proximate source. Best to keep an eye on the latest data from the WHO here: https://github.com/CSSEGISandData/COVID-19
The bottom line is that the extreme measures being taken by countries in terms of school closures, cancellation of events/ conferences, curtailment of travel etc is likely to plunge the global economy into a recession just as we saw with the abysmal Chinese PMIs. 10y yields plummeting to historic lows (0.98% intraday) may already be pricing in a global recession with the global PMI heading south of 50. It may also boost the bond proxies further & lead to an even greater blow off top in such factors as Risk (Low Vol). The related “Bernie” factor is also getting priced in which may explain why Healthcare has not held up better vs Biotechs – Super Tuesday shall tell. The looming recessionary prospects & uncertain spread of Covid 19 present obvious challenges to any factor prognostications hence let’s focus on taking stock of what happened in Feb, YTD and where that might take us next
- 1st we look at all ESBs YTD and then within Feb we compare the two sub-periods, pre-19th Feb and post-19th Feb. All analysis is based on the dollar-neutral daily re-balancing of factor re-ranks where the ESB’s factor allocations are still optimized at the prior month end. NB – we present below beta-neutral as well as monthly re-balanced versions.
- We categorize our 18 ESBs into those that broadly fall into Risk Off (Defensive) vs Risk On (Offensive) factors based on a study to be published with the regime mapping.
- YTD factor performance already had a pretty defensive tilt to it despite the solid start to the year for stocks up until the 2/20 correction began. To wit, only Growth was up YTD amongst the Risk On ESBs while on the Risk Off side most of our ESBs were up YTD (except for Dividends & Efficiency).
- During the 7d
sell-off, Defensive ESBs outperformed in line with intuition.
- Quality ESBs were up nicely (CSU +0.8%, EQ 2.0%, LEV 1.1%, PROF 2.2% and STAB 1.5%).
- Risk (aka Low Vol) was up +6.7% on a Dollar-Neutral basis.
- Feb was a tale of two-halves with pre-19th Feb and post-19th Feb moves cancelling out in cases like that of Dividends, Leverage & CSU.
- Value ESBs (DV & RV) continued their steady march downwards as a continuation of last year due to yields hitting all-time lows anddespite the curve steepening. The failure of Value is a much more nuanced story due to the parallel shift down in conjunction with the curve steepening because key constituent sectors like Energy continued hemorrhaging.
- Nearly all Risk On ESBs including SIRF, Size & Value (except Growth) continued their steady march downwards in Feb.
- Momentum ESBs (MOM, ENMOM, ARS) underperformed while ART worked for the full mo after netting out the two-halves.
Factor leadership started to change (as we’d expected) but only in the last two days – it remains to be seen if this is indeed the inflection point we were expecting given that we saw Risk sell off last Fri in favor of Value while Reversals kicked in. All we can be sure of is that there is much more factor vol to come before the dust settles and clearer patterns emerge as markets may well retest the lows despite the oversold bounce of Monday 3/2/20.
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