September 2022 Factor Commentary
- Of the six factors we track, low-volatility, momentum and value showed the best performance over the past month. Growth lagged.
- The dynamic factor portfolio outperformed the S&P 500 by 0.3% in August. Since the start of 2020, the dynamic factor strategy has outperformed the S&P 500 by 6.7%.
- After the latest rebalance, the dynamic factor portfolio remains overweight growth and size (small-cap) while being underweight value and quality.
- After a difficult July, our stock selection model rebounded strongly in August, as the basket of favored stocks outperformed the S&P 500 by 1.6% for the month. Year-to-date, the model’s basket of favored stocks has now outperformed the S&P 500 by 3.5%.
- Our market valuation methodology continues to see equities as overvalued relative to investment grade fixed income. We continue to expect muted returns and sustained volatility for the equity market in the coming months.
Factor Performance Review
We track the performance of six factors (growth, quality, low-volatility, momentum, size, and value) as part of our multi-factor strategy. Over the past month, the best factor was low-volatility, which outperformed the S&P 500 index by 2.7%. Value and momentum also turned in strong performances over the past month. The worst factor over the past month was growth (down 1.8% vs. the S&P 500). Performance for each of the six factors over the past month is shown as the gray bars in Fig. 1.
Fig. 1 – Recent Performance of Factors
Source: Bloomberg, S&P, Russell, Fundstrat analysis.
Looking back over a 3-month period (blue bars in Fig. 1), growth has seen the best performance, while quality, momentum and value have all lagged. On a trailing 12-month basis, the size factor continues to lag, as it has underperformed by 6.9%, but growth has also seen poor performance over the past year, underperforming the S&P 500 by 5.4% during that span.
Multi-Factor Portfolio Performance Review
We track a dynamic multi-factor portfolio that tilts weight toward the factors with the best recent performance, and away from the factors with the worst recent performance. Fig. 2 shows the cumulative performance of this dynamic multi-factor strategy relative to the S&P 500 since 1997.
Fig. 2 – Dynamic Multi-Factor Strategy Relative Performance
Source: Bloomberg, S&P, Russell, Fundstrat analysis.
From the start of 2020 through September 9, 2022, the dynamic multi-factor strategy returned 32.6%. Over that same period, the S&P 500 gained 25.9%, for 6.7% of outperformance for the dynamic multi-factor strategy. Fig. 3 below shows the monthly performance of the dynamic strategy vs. the S&P 500 since the start of 2020.
Fig. 3 – Dynamic Strategy Recent Relative Performance
Source: Bloomberg, S&P, Russell, Fundstrat analysis.
After underperforming in July, the dynamic strategy outperformed the S&P 500 in August, beating the benchmark by 0.3%. An underweight away from quality contributed to the dynamic factor strategy’s outperformance in August.
Dynamic Model: Factor Weights for September
Fig. 4 below indicates the latest weights assigned to each of the six factors in the dynamic multi-factor strategy. For the next month, the dynamic strategy remains overweight the growth and size (small-cap) factors while being underweight value and quality.
Fig. 4 – Updated Factor Weights in Dynamic vs. Static Multi-Factor Portfolio
Source: Bloomberg, S&P, Russell, Fundstrat analysis.
Baseline Stock Selection Model: Performance and Discussion
Our quantitative stock selection model uses composite factors across five dimensions (value, quality, momentum, estimates, and investment) to predict individual stock performance. The model produces a list of 100 favored investments from across the S&P 500. Fig. 5 below shows the historical performance of the basket of favored stocks, rebalanced monthly (orange line) compared to the S&P 500 (black dotted line).
Fig. 5 – Performance of Long Basket of Stock Selection Model (Relative to S&P 500)
Source: S&P, FactSet, Fundstrat analysis.
Fig. 6 (next page) shows the performance during August for each of the 5 composite factors that make up the stock selection model (blue bars), along with the performance of the overall model (orange bar at right). After struggling in July, the model once again outperformed in August, as its basket of favored stocks outperformed the S&P 500 index by 1.6% for the month. Year to date, the model has outperformed the S&P 500 by 3.5%.
The performance of the composite factors that make up the model were generally strong in August, as four of the five factors contributed positive return. Only the quality factor was negative for the month, as it (barely) underperformed the S&P 500 by 0.1%. The other four factors all outperformed the index by at least 1% in August, with the momentum factor turning in the best performance from among the five composite factors. After generating historically poor performance in July, the momentum factor rebounded strongly in August, as it outperformed the S&P 500 by 1.8%.
Fig. 6 – Performance of Factors and Overall Model for August
Source: S&P, FactSet, Fundstrat analysis.
Market Valuation: Residual Income Model
We use a residual income model to value the market[1]. The residual income model produces an estimate for the equity risk premium, or the additional return that equity investors are compensated over the risk-free rate. The history of the equity risk premium is shown in Fig. 7. At the end of August, the equity risk premium implied by the model was 3.49%. This latest value for the equity risk premium falls toward the lower end of the recent historical range of 3-5%.
Fig. 7 – History of the Equity Risk Premium Implied by the Residual Income Model
Source: S&P, FactSet, Fundstrat analysis.
Using the equity risk premium, we can evaluate the relative attractiveness of equities compared to investment grade fixed income via the ratio of their yields. Historically, when equities are expensive compared to fixed income (i.e., equities have a relatively low yield) the stock market experiences smaller average returns and higher volatility over the subsequent quarter (see Fig. 8).
Fig. 8 – Equity Market Return and Volatility Conditioned on Yield Ratio
Source: Ice Data Indices, LLC, retrieved from FRED, Federal Reserve Bank of St. Louis; August 31, 2022, S&P, FactSet, Fundstrat analysis.
At the end of August, the yield ratio indicated that equities continued to remain in the overvalued state. Based on the above relationship, we continue to expect muted returns and higher equity market volatility over the next 3 months.
[1] See Our Market Valuation Report
More from the author
Articles Read 1/2
🎁 Unlock 1 extra article by joining our Community!
Stay up to date with the latest articles. You’ll even get special recommendations weekly.
Already have an account? Sign In eb24a9-149908-7a226d-c6473b-495268
Already have an account? Sign In eb24a9-149908-7a226d-c6473b-495268
