Factors Go On The Defensive In Turbulent Q2

By Mark Barnes, PhD; Marlies van Boven, PhD; and Christine Haggerty, Global Investment Research

Global equity markets went into a protective crouch last quarter, and factor performance followed suit. Yield, Low Volatility and Value factors held their lead over Quality in most developed markets as investors rushed into steadier, less cyclically sensitive stocks and fled pricier growth stocks. In stark contrast, nearly all EM factors lagged except (small) Size. Regional return dispersion was greatest within Size, which ended the quarter as a top performer in Japan but was the biggest laggard in the UK.

Regional factor returns relative to benchmark – Q2 2022 (TR, LC %)

Data as of June 30, 2022. Results shown for regional factor returns represent hypothetical, historical performance, at Tilt 1, based on FTSE Global Equity Index Series and the FTSE Global Factor Index Series. Past performance is no guarantee to future results. Please see the end for important disclosures.

As we highlight in our latest Equity Factor Insights report, the continued outperformance of the Low Volatility factor in all but EM is unsurprising given the extreme turbulence plaguing markets this year. As the chart below illustrates, annualized one-month volatility spiked across equity markets in Q2, after markedly easing in the previous quarter, especially in the US.

Benchmark annualized 1-month volatility (LC %)

Data as of June 30, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Value rotation falters

Though still a source of outperformance in most markets through the first half, the rotation into Value from Quality lost steam in the final weeks of the quarter in all but the UK. (Both factors underperformed in the UK, but Quality more so.)

Regional Value returns relative to Quality (rebased)

Data as of June 30, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

The rotation’s slowdown coincided with rising investor fears of recession, as telegraphed by the continued bear flattening of the US yield curve – even as the real yield (dark blue line) had finally risen above zero (chart below). The 2yr/10yr yield curve has since inverted.

Select US Treasury bond yields (%)

Data as of June 30, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Exposures to growth-stock selloff a key swing factor

The collapse in Consumer Discretionary and/or Technology stocks was a dominant driver of global factor performance in Q2. Yield, Low Vol and Value benefited from their underweights to these industries across developed markets (with the exception of UK Value), while overweights in the same two groups generally detracted from Quality returns.

Unlike elsewhere, Yield and Low Vol were major laggards in Emerging markets, in part because Consumer Discretionary stocks there actually rose in Q2. (Negative stock selection in Technology also hurt.) In fact, all but EM Size lagged in the quarter, a stark reversal from the wholesale outperformance of EM factors in the previous two quarters.

Quality/Value premium returns to normal

Forward P/Es across factors continued to contract from their pandemic-crisis peaks, and most are now below 10-year averages in both absolute and relative terms. Value and Yield are the least expensive factors globally, while the strong rotation into Value from Quality has significantly narrowed the valuation gap between the two. By our analysis, the Quality premium versus Value has returned to its long-term averages in most markets and has nearly vanished in the UK.

Forward 12-month factor P/E ratios, average of six regions*

*Combined average of factor performance across FTSE USA, FTSE UK, FTSE Europe ex UK, FTSE Japan, FTSE Asia Pacific ex Japan and FTSE Emerging regional indexes. All data as of June 30, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

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