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 momentum, which outperformed the S&P 500 index by 4.6%. Value and low-volatility also performed well, outperforming the S&P 500 by 4.4% and 3.6%, respectively. The worst-performing factor over the past month was growth, which underperformed the S&P 500 by 4.9%. 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), momentum has seen the best performance, outperforming the S&P 500 by 10.5%. Since July, when momentum turned in a historically poor performance for the month, the momentum factor has been the best performing factor. On a trailing 12-month basis, the growth factor has shown the worst performance, as it has underperformed the S&P 500 by 12.8% 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 November 4, 2022, the dynamic multi-factor strategy returned 27.6%. Over that same period, the S&P 500 has gained 19.8%, for 7.8% 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.
The dynamic strategy outperformed the S&P 500 by 0.7% in October. So far in 2022, the dynamic strategy has outperformed the S&P 500 in seven of ten months. An overweight toward the size factor (small-cap stocks) and an underweight away from quality contributed to the dynamic factor strategy’s outperformance in October.
Dynamic Model: Factor Weights for November
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 is overweight the momentum and quality factors while being underweight low-volatility and growth.
Fig. 4 – Updated Factor Weights in Dynamic vs. Static Multi-Factor Portfolio
Source: Bloomberg, S&P, Russell, Fundstrat analysis.
Stock Rating Model: Performance and Discussion
Our quantitative stock rating model uses composite factors across five dimensions (value, quality, momentum, estimates, and investment) to predict individual stock performance. The stock rating 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 Rating Model (Relative to S&P 500)
Source: S&P, FactSet, Fundstrat analysis.
Fig. 6 (next page) shows the performance during October for each of the 5 composite factors that make up the stock rating model (blue bars), along with the performance of the overall model (orange bar at right). The model generated strong outperformance in October, as its basket of favored stocks outperformed the S&P 500 index by 2.2% for the month. Year to date, the model has outperformed the S&P 500 by 5.4%.
Not surprisingly, the composite factors that make up the stock rating model generally performed well in October. The value factor performed best, generating 4.9% of outperformance relative to the S&P 500. The estimates and momentum factors also contributed significant outperformance, gaining 3.0% and 2.6% relative to the S&P 500, respectively.
The long basket of the momentum factor (i.e. stocks that have performed best in the recent past, adjusted for their volatility) has continued its run of strong performance. After generating historically poor performance in July, the momentum factor generated 7.7% of cumulative outperformance relative to the S&P 500 from August through October.
Fig. 6 – Performance of Factors and Overall Model for October
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 October, the equity risk premium implied by the model was 2.57%.
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; October 31, 2022, S&P, FactSet, Fundstrat analysis.
At the end of October, the yield ratio indicated that equities remain overvalued relative to investment grade fixed income. Based on the above relationship, we expect muted returns and higher volatility for the equity market over the next 3 months.
[1] See Our Market Valuation Report
