Research.LeutholdGroup

All the talk has been about mega-cap growth stocks, but equities with low-quality characteristics have fared even better. High beta, negative earnings, and those with high short interest have trounced the rest of our universe.

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The preference for defensive industries and sectors in April led to the outperformance of low volatility stocks, while growth lagged. YTD factor results have been poor, with negative spreads for momentum, profitability, value, and low-vol.

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Volatility returned, as two large bank failures had investors questioning growth expectations. Value was hit the hardest; growth was the main beneficiary. 

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Factor performance stabilized in February, recovering from a brutal start to the year. While those dynamics bled into the first two days of February, the trend quickly reversed as interest rates bounced off recent lows and stayed on an upward trajectory for the rest of the month.

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After working well in 2022, Momentum took a beating out of the gates in 2023. Investors rejected the winners from last year and returned to the lowest quality and most speculative winners from the previous low-rate playbook.

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The rotation into Value continued into 2022, with Momentum joining the party and Growth the only blemish on the factor scorecard. 

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In a volatile year, protection is coming from what many may deem an unlikely suspect—the momentum factor. Contrary to popular belief, momentum tends to work better in down months than up months.

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While the market moves back into sell-off mode, everyone seems to be waiting for the inevitable hammer to drop on earnings. If and when that happens, does it give us any insight about performance prospects? Or does it just make forward P/E ratios less attractive?

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With equities rallying off bear market lows, factors also reversed during July. Except for Profitability, every factor category performed inversely to their year-to-date results. Momentum and Low Volatility were the biggest losers, while Growth was the biggest winner.

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High-beta stocks outdid everything else during July, after getting crushed during the first half of 2022. At the end of June, Momentum was more correlated with low beta than any other time in our history.

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From the end of 2020 through May, stocks in the top quintile of both value and momentum have returned 60% versus 7% for the overall universe. That compares to the brutal stretch from 2016-2020 when the only way momentum investing worked was to not only disregard valuations, but to actively buy the most expensive momentum stocks.

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The group is back to where it was before the pandemonium began, both on a price and valuation basis. While the move is likely to overshoot below median and historical lows, we think we’re closer to the final chapter than the midpoint.

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Through the first two-and-a-half months of 2022, factor performance maintained the trend established in 2021: Value outperformed everything else and Growth lagged. When the 10-2 year differential dropped near 20 bps on March 16th, Growth stocks outperformed from that day forward, while Profitability and Value suffered.

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It’s been a year since the retail crowd on WallStreetBets—a Reddit forum—banded together to “stick it to the shorts.” The event was short-lived, but the effects are still being felt throughout the market.

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After years of underperformance, Value was finally productive—it was the best factor we track. In general, overall factor performance was good, but worked much better within small- and mid-caps compared to large-caps. Value was especially superior outside of the large-cap universe.

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Growth has been outperforming Value since 2007, but the magnitude varies widely by market cap.  Large Cap has seen Growth outperform Value by a greater amount and with more consistency than has the Small Cap space. We use the S&P style indexes for reference.

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Financials have dramatically improved their Growth profile; a move that makes the traditionally value-oriented sector one of the most well-rounded segments of the equity market.

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In 2020, speculative Growth was easily the best-performing portion of the market. However, in 2021, that has reversed: Growth companies with negative earnings are underperforming everything else. 

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After years of underperformance, investors who pay attention to both Momentum and Value are finally being rewarded. The turnaround has been substantial, but the relative valuation of expensive Momentum vs. cheap Momentum stocks is still extremely elevated by historical standards.

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While Value outperformance continued throughout the first quarter, March saw higher-quality Value names take the lead. Prior to March, it was mostly the unprofitable companies that had driven the rotation.

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