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A key feature of 2022 has been the sustained strength of the US dollar
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
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
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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Hawkish Fed guidance sends FT Wilshire 5000 into reverse gear in August
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
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 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
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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Equities are a long duration asset class and returns should be viewed via the prism of long-time horizons
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
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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The 9.6% return for US equities in July exceeded all other major equity regions
While July saw a rally in most equity market regions (with the notable exception of China), the notable performance was delivered by US equities which outperformed the World ex US index by 5.8%.
Chart 1: Comparing regional equity returns in July (USD, TR, %)
Source: Refinitiv, FactSet
Looking at 10-year annualized returns US equities have delivered 13%, more than twice the 5.9% return from the World ex US.
Chart 2: Regional 10-year aggregate and annualized returns (USD, TR, %)
Source: Refinitiv, FactSet
The rally in the US relative performance in July saw it rebound back to levels seen earlier this year. By contrast, Emerging Market relative performance weakened
Chart 3: Relative performance charts for the US and Emerging Markets
Source: Refinitiv, FactSet
To identify the driver of US equity outperformance in July, it is useful to utilize sector weighted performance contribution analysis. Exhibit 4 compares the sector weighted contributions for the US and the World ex US indexes. The majority of the almost 6% outperformance of US equities in July was almost entirely due to the scale of contributions from the Technology and Consumer Discretionary sectors.
Chart 4: Sector weighted performance contributions US and World ex US for July
Source: Refinitiv, FactSet
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The 9.6% return in July was driven by a rotation to growth stocks
July witnessed a strong recovery in the FT Wilshire 5000 index driven by a rally in growth stocks. Mounting concerns about recessionary headwinds boosted demand for long duration growth stocks by reducing discount rates (via lower nominal and real yields) and by increasing demand for their defensive attributes. The 9.6% rally in the FT Wilshire 5000 was the fifth largest monthly return in the last 20 years.
Chart 1: The fifth largest monthly return over the last 20 years
Source: Wilshire
Chart 2: Large-cap growth relative performance has responded to declining real yields
Source: Wilshire, FactSet
Sector weighted performance contributions take account of both the performance and respective sector weightings. Comparing the sector weighted contributions for large-cap growth and large cap value in July, it can be seen that the majority of growth's 6.4% outperformance relative to value was due to the size of the respective contributions from the key growth sectors - Technology, Consumer Goods and Services and Digital Information.
Chart 3: The sector weighted contributions to July performance
Source: Wilshire
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The first half of 2022 witnessed a significant correction to the FT Wilshire 5000 index taking the index back to levels last seen in early 2021
A key feature of the sell off was the rotation out of long duration growth and tech stocks in response to rising real yields. It also produced a statistically significant decline in PE valuation.
As at the close on June 30th 2022 the FT Wilshire 5000 index delivered a negative return of -20.9% for the first half of the year. Most of the negative return was delivered by the substantial Q2 correction of -16.8% as market sentiment reacted to mounting stagflation angst and increasingly hawkish Federal Reserve guidance.
Chart 1: The largest half year correction on record
Source: Wilshire, Refinitiv
Chart 2: The correction has rewound the index back to February 2021 levels:
Source: Wilshire, Refinitiv, FactSet
However, despite the pullback US equities have still delivered strong nominal and real long-term returns measured on both an aggregate and annualized basis.
Chart 3: Strong long term Nominal and Real returns
Source: Wilshire, Refinitiv, FactSet
A significant element of the correction was driven by a rotation out of long duration growth and technology stocks as real yields increased
Chart 4: Rising Real Yields have led to Growth stock underperformance/Value stock performance
Source: Wilshire, Refinitiv, FactSet
The growth stock underperformance was dominated by the negative sector weighted performance contribution delivered by the Digital Information, Technology and Consumer Goods and Services sectors. Only the Energy sector posted a positive return contribution YTD.
Chart 5: FT Wilshire 500 Sector Weighted Performance Contributions YTD
Source: Wilshire
The correction has produced a significant and rapid PE decline - producing a rarely seen 3 standard deviation move.
Chart 6: A rapid and large decline in the PE valuation
Source: Refinitiv, FactSet
2022 has witnessed a large rotation in both factor and style indices
Low beta and Value were the best performing factors with momentum lagging. The "Pure" quality factor also outperformed reflecting increased risk aversion. The 16% outperformance of the Value style relative to Growth was a notable feature of the first half of the year.
The first half of 2022 produced large rotation in factors utilizing the FT Wilshire "Pure" factor methodology and data. In terms of relative performance, the Low Beta and Value Factors outperformed the most (responding to rising real yields) with the momentum factor underperforming significantly.
Interestingly the "Pure" Quality factor outperformed as well (unlike most other Quality Factor indices) - this reflects the Pure Factor methodology stripping away unintended sector and factor exposures. The outperformance of the quality factor reflected the desire to seek protection against recessionary headwinds.
Chart 1: Pure factor relative performance YTD
Source: Wilshire
Value has persistently outperformed while quality outperformed strongly in Q2. By contrast Momentum declined significantly in Q2 .
Chart 2: Relative return of Pure Factors YTD
Source: Wilshire
In terms of the size indices large and small delivered similar returns YTD with Micro cap slightly underperforming. The scale of the Value style outperformance was the key feature in the first half of 2022.
Chart 3: FT Wilshire 5000 size and style returns
Source: Wilshire
A notable feature of 2022 market dynamics has been the 16% outperformance of Value relative to Growth. The Growth /Value relative return ratio appears to be returning to pre-Covid levels
Chart 4: Growth Style Index returns relative to Value
Source: Wilshire
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