To the casual observer, the backdrop to this year’s record-breaking stock rally has been one of epic calm in markets. To Wall Street’s math wizards, it’s been anything but.
Quantitative traders who pick stocks based on rules like how cheap or how stable they appear — known as factors — are getting lashed by some of the most violent swings in years, as investors grapple with a US economy that continues to expand in the era of elevated interest rates.
While broad gauges of turbulence for equity benchmarks sit below their long-term average, the 60-day volatility of a strategy that buys small-capitalization stocks has surged near the highest in three years. A trade that bids up companies with strong balance sheets and reliable profits, known as quality, is the rockiest since early 2021. Even an investing approach that favors steady stocks is the least steady in a year, market-neutral Dow Jones indexes show.
The volatility beneath the surface of rallying indexes is sending a message for both systematic traders and their discretionary peers: A risk-on rotation may be afoot as strategies sensitive to the US business cycle start to enjoy a spirited rally.
It’s early days yet. But any oncoming shift in investment preferences threatens the powerful dominance of a handful of Big Tech companies like Nvidia Corp., which is due to report earnings at the Wednesday market close. It would also prove a boon for little-loved factors this year known as size and value, while popular trades like growth and momentum would falter.
“There’s an element of exhaustion of chasing those very high valuations,” said Amadeo Alentorn, the lead manager of the $2 billion Jupiter Merian Global Equity Absolute Return Fund, who has shifted positioning to favor value shares in recent weeks. “There are names that are high-quality, maybe are not as glamorous and sexy as some of these tech names, but they offer much better value at this point.”
All told, the start of 2024 has been broadly positive for many systematic stock investors despite the rising factor volatility. Equity quants overall have posted a 6.6% return so far this year, making them the best performers among hedge-fund strategies tracked by PivotalPath. The AQR Equity Market Neutral Fund, a bellwether of multi-factor portfolios, is up 5.1%.
Read the full article here by Justina Lee of Bloomberg News, Advisor Perspectives
