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The Risk Off move in February had a different dynamic compared to those of 2022

March 2, 2023

While the FT Wilshire 5000 adopted a risk off tone in February…

Market Navigation

Having rallied in January on optimism that a recession would be avoided, the release of surprisingly strong labor market data forced the market to reappraise the trajectory of interest rates (dispelling any notion of them nudging lower later this year).This generated a cautious risk off tone that pushed the FT Wilshire 5000 -2.4% lower in February. However, the index is still up 4.4% YTD.

Exhibit 1: Risk aversion came to the fore in February driven by a rise in market interest rate forecasts

Source: Wilshire. Data as of February 28, 2023.

… the drawdown had a different dynamic compared to other recent pull backs. Here are 4 examples:

1 - Despite market weakness the technology sector leadership persisted

A key feature to the 2022 drawdown was the persistency of the decline in technology stocks. Interestingly, the February risk off move saw the technology sector outperform, delivering a positive sector weighted contribution to return (see Exhibit 2). In fact, year to date the technology and digital information and sectors have been the dominant positive contributions to aggregate returns. This is a mirror opposite to the 2022 dynamic.

Exhibit 2 : Sector weighted contributions to aggregate returns - YTD and February 2023

Source: Wilshire. Data as of February 28, 2023.

2 - The rotation to the Growth style (v Value) also persisted in February.

The positive inflection in the performance of the FT Wilshire Large Cap Growth index relative to Value that started in January persisted in February. This is a reversal of the 2022 dynamic (Exhibit 3). This rotation has occurred despite the rise in bond yields and real yields in February - these were key drags on highly valued Growth stocks in 2022.

Exhibit 3: Growth v Value style performance continues to inflect higher.

Source: Wilshire. Data as of February 28, 2023.

3 - A change in market dispersion dynamics in 2023 - the shift back to the dominance of the few.

Exhibit 4 compares the performance of the top 10 stocks in the FT Wilshire 5000 to the performance of the median stock to gauge the degree of performance dispersion. 2022 saw the median stock outperform the top 10 stocks implying a widening of dispersion. However, 2022 year-to-date has seen the opposite occur with the top 10 stocks significantly outperforming the median stock. This narrowing of dispersion has marked the return to the dominance of the few that characterized the market prior to 2022.

Exhibit 4: Comparing the return generated by the top 10 stocks v the median stock

Source: Wilshire. Data as of February 28, 2023.

4 - The 2023 YTD returns have been driven by a PE expansion - the opposite pattern to 2022

Exhibit 5 decomposes market returns drivers into the contribution from changes to dividends, changes to EPS forecasts and changes to valuation. In the case of the US market, over the last 12 months the negative return was mainly attributable to the significant decline in PE valuation (grey bar). In 2023 the opposite has occurred with the positive return been driven by the expansion in the PE multiple.

Exhibit 5: The decomposition of market returns - 12months and YTD

Source: Refinitiv. Data as of February 28, 2023.

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Two distinct phases to the recovery in markets since mid-October

February 3, 2023

The FT Wilshire 5000 has appreciated 14.5% from the mid-October low

Market Navigation

Anticipation of a pivot in the degree of Fed hawkishness was the catalyst behind the recovery in risk appetite that commenced in mid-October last year. This positive momentum continued in January producing a return of 6.9% for the FT Wilshire 5000 for the month. From the mid-October low, the FT Wilshire 5000 had appreciated 14.5% to the end of January.

Exhibit 1: The risk rally that started in mid-October last year continued into January

Source: Wilshire. Data as of January 31, 2023.

However, the rally can be dissected into two distinct phases

Exhibit 2 breaks the rally in the FT Wilshire 5000 since mid-October into two phases (October to December versus January). In the first phase, the rally was still defensive in nature represented by the marked outperformance of the Value style. By contrast, January saw a similar return for the market but this time it was driven by the outperformance of the Growth style.

Exhibit 2: A rotation to the Growth Style in January

Source: Wilshire. Data as of January 31, 2023.

The decline in real yields has contributed to the rally in the Growth style

Exhibit 3 shows relative performance of the FT Wilshire large Cap Growth versus Value and the US 10yr TIP real yield inverted. Style rotation responds to inflections in the real yield. The decline in the real yield in January has contributed to the Growth style outperforming the Value style by 5.7%  

Exhibit 3: Growth style outperformed in January helped by falling real yields

Source: Wilshire, Refinitiv. Data as of January 31, 2023.

Growth benefitted from the contribution from 4 sectors in January

Exhibit 4 compares the sector weighted contributions to the returns for the Growth and Value style indexes in January. Growth benefitted significantly  from the larger respective contributions generated by four sectors - Digital Information, Technology, Consumer Goods and Transportation. These tend to be seen as long duration growth sectors that respond positively to declining real yields.

Exhibit 4: Comparing the sector weighted contributions for Growth and Value

Source: Wilshire Data as of January 31, 2023.

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2022 performance review: Six key observations from an ‘annus horribilis’

January 5, 2023

The FT Wilshire 5000 delivered the 4th largest annual drawdown since 1970

The almost 6% decline in December resulted in the FT Wilshire 5000 registering a decline of -19% for 2022. This constitutes the fourth largest annual drawdown since the inception of the index in 1970.

Markets and risk aversion responded to a perfect storm of war (Ukraine), inflation, real income and supply chain shocks and a rapid rotation to restrictive financial conditions just as economies were recovering from the COVID impact - all making 2022 an annus horribilis.

Exhibit 1: Largest Calendar year drawdowns for the FT Wilshire 5000

Source: Wilshire and Refinitiv. Data as of December 31. 2022

 

A lack of diversification opportunities

What made 2022 particularly difficult was the lack of diversification opportunities. For example, Exhibit 2 shows that 2022 was the first time in 40 years that both bonds and equities delivered simultaneous negative returns.

Exhibit 2: Simultaneous decline in US equity and bond returns

Source: Wilshire and Refinitiv. Data as of December 31. 2022

Two sectors contributed almost half of the aggregate decline in US equities

Exhibit 3 shows the ranked FT Wilshire 5000 sector-weighted performance contributions for 2022. Almost half of the aggregate decline in the FT Wilshire 5000 is accounted for by the scale of negative contributions delivered by the Digital Information and Technology sectors.

Exhibit 3: Sector weighted contributions for the FT Wilshire 5000 in 2022

Source: Wilshire. Data as of December 31, 2022

The other key market dynamic was the rotation away from Growth towards Value style

Exhibit 4 depicts the -25.1% underperformance of the Growth style relative to Value in 2022. This has effectively unwound the rotation to Growth that occurred during the immediate aftermath of the COVID pandemic.

An important driver of underperformance of the Growth style was the negative valuation impact of rising real yields in 2022.

Exhibit 4: Growth Style performance relative to Value Style

Source: Wilshire. Data as of December 31. 2022

Exhibit 5 examines the sector-weighted contributions for both the Growth and Value style indices. Value benefitted from a larger positive contribution from the energy sector compared to the Growth Style. It also benefitted from not incurring the scale of negative contributions in the digital information, technology, and consumer goods sectors.

Exhibit 5: Comparing the sector weighted contributions for the Growth and Value Style indices

Source: Wilshire. Data as of December 31. 2022

2022 saw an improvement in performance dispersion

Comparing the performance of the top 10 stocks by market cap (equally weighted) to the performance of the median stock in the FT Wilshire 5000 index is a useful gauge of performance dispersion. Exhibit 6 shows the scale of reversal in dispersion from 2021 to 2022. In 2021, median stock performance significantly lagged the return delivered by the top 10 stocks (negative dispersion). 2022 saw the median stock outperform delivering an improvement in dispersion characteristics.

Exhibit 6:  Comparing the performance of the top 10 stocks to the median stock

Source: Wilshire. Data as of December 31. 2022

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October saw US equities rally on speculation the Fed might change tack

November 2, 2022

The FT Wilshire 5000 rallies 8.2% in October

Market Navigation

Having fallen sharply over the prior four-week period the FT Wilshire 5000 started to inflect sharply higher from mid-October closing out the month with a +8.2% return. There were two principal catalysts behind the recovery in risk appetite. The first was the market registered as significantly oversold in mid -October, reaching levels that typically see a subsequent rebound. The second catalyst was speculation that the Federal Reserve was becoming increasingly concerned about tightening too aggressively given mounting recession headwinds.

Exhibit 1: A robust recovery in the latter half of October

Source: Wilshire. Data as of October 31, 2022.

October saw a continued preference for Value vs Growth style

 

A key attribute of the recovery in risk appetite was the notable preference for Value over Growth as measured by the FT Wilshire 5000 style indexes. In October the Large Cap Value style index delivered a return of 11.6% while the Large Cap Growth style index only appreciated 4.2%. This rotation has been a dominant theme through the course of 2022 with Value outperforming Growth by 21.3% year to date.

Exhibit 2: A continuation of the sustained preference of Value vs Growth in 2022

Source: Wilshire. Data as of October 31, 2022

Financials and Energy sectors delivered the largest performance contributions

Dissecting market returns using sector weighted contributions ( the combined impact of sector performance and sector weighting) October saw the largest positive contribution from Financials followed by energy. Real estate and transportation sectors delivered the lowest contributions.

Exhibit 3: October performance driven by Financials and Energy

Source: Wilshire. Data as of October 31, 2022

 

The Year-to-Date drawdown of-24.9% is the sixth largest in 40 years

The YTD drawdown of-24.9% as of 30th is now the sixth largest witnessed over the last 40 years as shown in Exhibit 3.

Exhibit 4: Putting the YTD drawdown into perspective

 Source: Wilshire and Refinitiv. Data as of October 31, 2022

 

Differentiating bear market rallies vs meaningful inflection points

November 2, 2022

Bear markets are not linear – they typically witness numerous rallies

Market Navigation

From January 3rd to the recent low on October 14, the the FT Wilshire 5000 had registered a drawdown of -25.9% the sixth largest since 1980. The key observation about bear markets is that they are not linear – in fact they often move in a sawtooth manner marked by numerous bear market rallies. This has been observable in the trajectory of the FT Wilshire 5000 returns this year (see chart below). Bear market rallies reward the ‘sell the bounce’ discipline, the antithesis of ‘buy the dip’.

Exhibit 1: Bear markets typically see numerous tradeable rallies

Source: Wilshire and Refinitiv. Data as of October 31, 2022

Just under half the days in a bear market register positive returns

To reiterate the point that bear markets are not linear we have measured the trading pattern of bear markets (lasting more than three months) registered by the FT Wilshire 5000 since 1980. This shows that around 45% of the trading days witness upward moves. The bear market is driven by the compounding effect of the average daily move in a down day being -1.4% vs the average daily move on an up day being +1%.

Exhibit 2: The trading pattern of bear markets

Source: Wilshire and Refinitiv. Data as of October 31, 2022

How to differentiate a bear market rally from a sustained inflection point?

If bear markets witness numerous bear market rallies, how can we identify when a rally is marking a nadir followed by a sustained positive move?

One answer to this is to wait for key technical signal confirmation. The ‘Golden Cross’ (the positive intersect of the 50-day moving average with the 200-day moving average where the latter has bottomed) is a useful tool aiding the identification of major market inflection points.

Exhibit 3: The ‘Golden Cross’ helps identify key inflection points

Source: Wilshire and Refinitiv. Data as of October 31, 2022

Q3 witnessed a dramatic "U-turn" in risk appetite

October 3, 2022

The rapid reversal in risk appetite in Q3 has produced a retest of the June lows

Market Navigation

August witnessed a significant reversal in risk appetite mid-month in response to a succession of hawkish Fed guidance. This brought an end to the +18.6% two-month rally (and optimism) that started on June 16 and peaked on August 16. Since the mid-August peak, the FT Wilshire declined -16.7% over the remainder of the quarter to produce a -4.4% return for the three-month period. The strength of the rotation to risk aversion has now driven the index below the low point reached in mid-June.

Exhibit 1: A rapid reversal in returns over the last six weeks of Q3

One of the largest six-week drawdowns since 2006

Exhibit 2 puts the scale of the drawdown in US equities over the latter half of Q3 into perspective - showing that it is almost a three standard deviation event. Outside of the GFC and COVID sell offs, this is one of the largest six-week drawdowns since 2006.

Exhibit 2: Putting the six-week drawdown into perspective

The YTD drawdown of -24.9% is the sixth largest in 40 years

The YTD drawdown of -24.9% as of Sept. 30 is now the sixth largest witnessed over the last 40 years as shown in exhibit 3.

Exhibit 3: Putting the YTD drawdown into perspective

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The surge in the dollar is creating market distortions

October 3, 2022

A key feature of 2022 has been the sustained strength of the US dollar

Market Navigation

2022 has seen persistent strength in the US dollar aided by positive interest rate differentials, haven status and the perception the US is less exposed to the Ukraine invasion energy shock. Exhibit 1 shows the long-term performance of the DXY dollar index and the 16.8% YTD return has pushed the dollar back to levels not seen since the turn of the century.

Exhibit 1: The dollar is back to levels last seen over 20 years ago

The quantum of the appreciation of the dollar accentuates regional equity return differences

FX swings can have a large impact on unhedged regional equity returns depending on the location of investors. Due to GBP, Euro and JPY weakness, investors in the UK, Europe and Japan have a very different perception of regional market returns based in GBP, Euro and JPY versus the returns seen by a US dollar-based investor over both Q3 and YTD periods. For instance, it can be seen in exhibit 2 that UK unhedged investors (courtesy of the 8.2% decline in the pound) saw a positive return from US equities in Q3.

Exhibit 2: Comparing UK and US (unhedged) equity return profiles for Q3

The strength of the dollar is mitigating the impact of declining commodity prices

Most commodity prices are denominated in dollars. Consequently, when the dollar appreciates it offsets the impact of any fall in prices to non - US dollar-based participants (and vice versa). For instance, exhibit 3 shows that although the oil price declined 22% in Q3 in dollar terms, due to the depreciation of sterling, euro, and the yen against the dollar the oil price drop denominated in those currencies is more muted. The distortion of the move in the dollar on the regional oil price is even more extreme looking at two-year data.

Exhibit 3: The impact of the dollar on regional oil price moves

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August was a month of two halves for FT Wilshire 5000 return delivery

September 6, 2022

Hawkish Fed guidance sends FT Wilshire 5000 into reverse gear in August

Market Navigation

August witnessed a significant reversal in risk appetite mid-month in response to a succession of hawkish Fed guidance. This bought an end to the +18.6% two-month rally that started on June 16 and peaked on Aug. 16. Since the mid-month peak, the FT Wilshire has declined -8.1%, producing a -3.8% move for the month of August.

Exhibit 1: August brought an end to the two-month rally  

 

August saw a rotation back to small cap and value stocks

The mid-August reversal also produced a rotation in style performance. The table below shows that most of the underperformance of large cap relative to small cap in August was attributable to the larger negative contributions from the financials, digital info and services, health care and technology sectors.

Exhibit 2: Four sector-weighted contributions account for small cap outperformance

Rising bond yields cause growth to lose momentum vs value

Rising bond yields impacted the highly valued long duration growth stocks in August and this resulted in the growth style (with its large exposure to the technology and digital information sectors) losing momentum relative to value as the month progressed.

Exhibit 3: Two sector weighted contributions account for growth underperformance

Still a way to go before the growth vs value trade reverts to 2016/17 levels

Exhibit 4 puts the growth vs value rotation into a longer perspective. Despite the scale of value outperformance so far this year, the relative trade still has a long way to go in order for it to mean revert back to 2016/17 levels (parity levels).

Exhibit 4: The long term perspective on Growth v Value relative performance

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The FT Wilshire 5000 continues to deliver strong long term real returns

September 6, 2022

Equities are a long duration asset class and returns should be viewed via the prism of long-time horizons

Market Navigation

Although recent volatility and inflation angst have produced negative nominal and real returns for the FT Wilshire 5000 over the last 12 months, it is worth remembering that equities are a long duration asset class and returns should be viewed via the prism of long-time horizons.

The chart and table below show the progression of FT Wilshire returns over the last 20 years. Real annualized returns have exceeded 7% over the five-,10- and 20-year periods.

Exhibit 1: The aggregate and annualized nominal and real total returns for the FT Wilshire 5000

The nominal return profile of the FT Wilshire 5000 style indices

In Exhibit 2, over a 20-year period small cap's annualized returns of 10.8% have exceeded the 9.8% delivered from large cap. However, small cap's annualized returns have lagged large cap returns over three-, five- and 10-year time frames.

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