By Pierre Debru, Director, Research, WisdomTree
This summer, equities and in particular tech stocks continued their race to the top. In July and August alone, the S&P 500 was up +13.2% and the Nasdaq 100 Index +19.4%. Despite a small correction in September, this led to a second green quarter for equities.
However, like earlier this year the good fortune was not evenly spread, and Tech stocks have continued to benefit above all else. Tech Mega Caps are now at a record level and the 5 biggest stock in the S&P 500 represent almost a quarter of the market cap of the index.
In the third instalment of the WisdomTree Quarterly Equity Factor Review , we aim to shed some light on how equity factors behaved over the last 3 months and how this has impacted investors’ portfolios.
Looking forward to more uncertainty and an unpredictable US election, it is hard to discount the possibility that all-weather factors like Quality and Momentum continue to benefit in the near future.
The third quarter of this year started like the second ended with a very powerful rally driven in most part by Tech and “Work from Home” themes. Equity markets have now erased all of the losses of the first quarter. However, since early September, the rally seems to have stalled on fears of a second wave for the Pandemic in Europe, Brexit uncertainties and a lack of a new agreed fiscal stimulus package in the US. This may not be so surprising with the US elections only a few weeks away and markets predicting an increase in volatility and overall uncertainties for the start of Q4.
Source: WisdomTree, Bloomberg. 31st December 2019 to 30th September 2020. Historical performance is not an indication of future performance and any investments may go down in value.
In the third quarter, the drivers of equity factor performance remained aligned with the first half of the year:
Source: WisdomTree, Bloomberg. 30th June 2020 to 30th September 2020. Historical performance is not an indication of future performance and any investments may go down in value.
In the third quarter, the MSCI World performed strongly in July (+4.8%) and August (+6.7%) but stalled in September (-3.4%). In such a contrasted environment, only two equity factors managed to deliver outperformance in all 3 calendar months: Momentum and Quality. Both factors managed to capture the rally and more than match the market cap weighted index performance while cushioning the slight drawdown.
Source: WisdomTree, Bloomberg. 30th June 2020 to 30th September 2020. Historical performance is not an indication of future performance and any investments may go down in value.
As expected, Min Volatility performed the best in September but failed to deliver performance in July and August. Surprisingly more cyclical factors like Size and Value did not manage to outperform at the end of the rally in July and August.
Last quarter we had pointed in this blog to the expected uncertainty and the likelihood for all-weather factors like Quality and Momentum to do well in such environments. Looking forward to the end of the year, the uncertainty in the market appears even more certain. As of the 1st October, the CBOE Volatility Index (VIX) Futures Curve already points to a 6 point increase (up to 33). In such an unpredictable world, it is hard to discount the possibility that the all-rounders (Quality and Momentum) continue to benefit.
Before moving to valuations, let’s take a quick detour to look at the aforementioned underperformance of cyclical factors in Q3. A lot has already been written about the unusual concentration and performance at the top of the S&P 500. The fact is that the Top 5 now represents a record 22.5% of the index (Apple 6.7%, Microsoft 5.7%, Amazon 4.8%, Facebook 2.3% and Alphabet 3.1%). Those 5 stocks spread across 3 sectors: Information & Technology, Communications Services and Consumer Discretionary, even if investors might naturally be thinking of them all as ‘tech stocks’.
Looking at the sectorial performance attribution of US equity factors in Q3 it is very interesting to note that:
Looking forward to the next quarters, it is possible that the S&P 500 Top 5 mean reverts in weight and in performance, if and when that happens most factors including Quality should benefit while Momentum may suffer from such mean reversion.
Source: WisdomTree, Bloomberg. 30th June 2020 to 30th September 2020. Historical performance is not an indication of future performance and any investments may go down in value.
Valuations are up across the board
After the sharp increase in Q2, valuations have stabilized in Q3. Most Factors got slightly more expensive except for Size.
Source: WisdomTree, Bloomberg. As of 30th September 2020. Historical Data represents the last 3 years from 30th September 2017 to 30th September 2020. Historical performance is not an indication of future performance and any investments may go down in value.