Having rallied in January on optimism that a recession would be avoided, the release of surprisingly strong labor market data forced the market to reappraise the trajectory of interest rates (dispelling any notion of them nudging lower later this year).This generated a cautious risk off tone that pushed the FT Wilshire 5000 -2.4% lower in February. However, the index is still up 4.4% YTD.

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Exhibit 1: Risk aversion came to the fore in February driven by a rise in market interest rate forecasts

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^{Source: Wilshire. Data as of February 28, 2023.}

… the drawdown had a different dynamic compared to other recent pull backs. Here are 4 examples:

1 - Despite market weakness the technology sector leadership persisted

A key feature to the 2022 drawdown was the persistency of the decline in technology stocks. Interestingly, the February risk off move saw the technology sector outperform, delivering a positive sector weighted contribution to return (see Exhibit 2). In fact, year to date the technology and digital information and sectors have been the dominant positive contributions to aggregate returns. This is a mirror opposite to the 2022 dynamic.

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Exhibit 2 : Sector weighted contributions to aggregate returns - YTD and February 2023

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^{Source: Wilshire. Data as of February 28, 2023.}

2 - The rotation to the Growth style (v Value) also persisted in February.

The positive inflection in the performance of the FT Wilshire Large Cap Growth index relative to Value that started in January persisted in February. This is a reversal of the 2022 dynamic (Exhibit 3). This rotation has occurred despite the rise in bond yields and real yields in February - these were key drags on highly valued Growth stocks in 2022.

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Exhibit 3: Growth v Value style performance continues to inflect higher.

^{Source: Wilshire. Data as of February 28, 2023.}

3 - A change in market dispersion dynamics in 2023 - the shift back to the dominance of the few.

Exhibit 4 compares the performance of the top 10 stocks in the FT Wilshire 5000 to the performance of the median stock to gauge the degree of performance dispersion. 2022 saw the median stock outperform the top 10 stocks implying a widening of dispersion. However, 2022 year-to-date has seen the opposite occur with the top 10 stocks significantly outperforming the median stock. This narrowing of dispersion has marked the return to the dominance of the few that characterized the market prior to 2022.

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Exhibit 4: Comparing the return generated by the top 10 stocks v the median stock

^{Source: Wilshire. Data as of February 28, 2023.}

4 - The 2023 YTD returns have been driven by a PE expansion - the opposite pattern to 2022

Exhibit 5 decomposes market returns drivers into the contribution from changes to dividends, changes to EPS forecasts and changes to valuation. In the case of the US market, over the last 12 months the negative return was mainly attributable to the significant decline in PE valuation (grey bar). In 2023 the opposite has occurred with the positive return been driven by the expansion in the PE multiple.

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Exhibit 5: The decomposition of market returns - 12months and YTD

^{Source: Refinitiv. Data as of February 28, 2023.}

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Anticipation of a pivot in the degree of Fed hawkishness was the catalyst behind the recovery in risk appetite that commenced in mid-October last year. This positive momentum continued in January producing a return of 6.9% for the FT Wilshire 5000 for the month. From the mid-October low, the FT Wilshire 5000 had appreciated 14.5% to the end of January.

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Exhibit 1: The risk rally that started in mid-October last year continued into January

^{Source: Wilshire. Data as of January 31, 2023.}

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However, the rally can be dissected into two distinct phases

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Exhibit 2 breaks the rally in the FT Wilshire 5000 since mid-October into two phases (October to December versus January). In the first phase, the rally was still defensive in nature represented by the marked outperformance of the Value style. By contrast, January saw a similar return for the market but this time it was driven by the outperformance of the Growth style.

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Exhibit 2: A rotation to the Growth Style in January

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^{Source: Wilshire. Data as of January 31, 2023.}

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The decline in real yields has contributed to the rally in the Growth style

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Exhibit 3 shows relative performance of the FT Wilshire large Cap Growth versus Value and the US 10yr TIP real yield inverted. Style rotation responds to inflections in the real yield. The decline in the real yield in January has contributed to the Growth style outperforming the Value style by 5.7%  

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Exhibit 3: Growth style outperformed in January helped by falling real yields

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^{Source: Wilshire, Refinitiv. Data as of January 31, 2023.}

Growth benefitted from the contribution from 4 sectors in January

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Exhibit 4 compares the sector weighted contributions to the returns for the Growth and Value style indexes in January. Growth benefitted significantly  from the larger respective contributions generated by four sectors - Digital Information, Technology, Consumer Goods and Transportation. These tend to be seen as long duration growth sectors that respond positively to declining real yields.

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Exhibit 4: Comparing the sector weighted contributions for Growth and Value

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^{Source: Wilshire Data as of January 31, 2023.}

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The almost 6% decline in December resulted in the FT Wilshire 5000 registering a decline of -19% for 2022. This constitutes the fourth largest annual drawdown since the inception of the index in 1970.

Markets and risk aversion responded to a perfect storm of war (Ukraine), inflation, real income and supply chain shocks and a rapid rotation to restrictive financial conditions just as economies were recovering from the COVID impact - all making 2022 an annus horribilis.

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Exhibit 1: Largest Calendar year drawdowns for the FT Wilshire 5000

^{Source: Wilshire and Refinitiv. Data as of December 31. 2022}

A lack of diversification opportunities

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What made 2022 particularly difficult was the lack of diversification opportunities. For example, Exhibit 2 shows that 2022 was the first time in 40 years that both bonds and equities delivered simultaneous negative returns.

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Exhibit 2: Simultaneous decline in US equity and bond returns

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^{Source: Wilshire and Refinitiv. Data as of December 31. 2022}

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Two sectors contributed almost half of the aggregate decline in US equities

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Exhibit 3 shows the ranked FT Wilshire 5000 sector-weighted performance contributions for 2022. Almost half of the aggregate decline in the FT Wilshire 5000 is accounted for by the scale of negative contributions delivered by the Digital Information and Technology sectors.

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Exhibit 3: Sector weighted contributions for the FT Wilshire 5000 in 2022

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^{Source: Wilshire. Data as of December 31, 2022}

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The other key market dynamic was the rotation away from Growth towards Value style

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Exhibit 4 depicts the -25.1% underperformance of the Growth style relative to Value in 2022. This has effectively unwound the rotation to Growth that occurred during the immediate aftermath of the COVID pandemic.

An important driver of underperformance of the Growth style was the negative valuation impact of rising real yields in 2022.

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Exhibit 4: Growth Style performance relative to Value Style

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^{Source: Wilshire. Data as of December 31. 2022}

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Exhibit 5 examines the sector-weighted contributions for both the Growth and Value style indices. Value benefitted from a larger positive contribution from the energy sector compared to the Growth Style. It also benefitted from not incurring the scale of negative contributions in the digital information, technology, and consumer goods sectors.

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Exhibit 5: Comparing the sector weighted contributions for the Growth and Value Style indices

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^{Source: Wilshire. Data as of December 31. 2022}‍

2022 saw an improvement in performance dispersion

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Comparing the performance of the top 10 stocks by market cap (equally weighted) to the performance of the median stock in the FT Wilshire 5000 index is a useful gauge of performance dispersion. Exhibit 6 shows the scale of reversal in dispersion from 2021 to 2022. In 2021, median stock performance significantly lagged the return delivered by the top 10 stocks (negative dispersion). 2022 saw the median stock outperform delivering an improvement in dispersion characteristics.

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Exhibit 6:  Comparing the performance of the top 10 stocks to the median stock

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^{Source: Wilshire. Data as of December 31. 2022}

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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.

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Chart 1: The fifth largest monthly return over the last 20 years

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^{Source: Wilshire}

Chart 2: Large-cap growth relative performance has responded to declining real yields

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^{Source: Wilshire, FactSet}

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‍The Technology, Consumer Goods and Digital Info sectors drove Growth performance

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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

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^{Source: Wilshire}

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^{Index 15303321 E0922}‍

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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.

A rotation to Low Beta and Value

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.

The Pure quality factor also outperformed

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.

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Chart 1: Pure factor relative performance YTD

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_{Source: Wilshire}

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Mapping the progression of Pure Factor relative performance YTD

Value has persistently outperformed while quality outperformed strongly in Q2. By contrast Momentum declined significantly in Q2 .

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Chart 2: Relative return of Pure Factors YTD

^{Source: Wilshire}

Value outperformance the key feature of the FT Wilshire 500 Size and Style Index returns

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.

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Chart 3: FT Wilshire 5000 size and style returns

^{Source: Wilshire}

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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

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Chart 4: Growth Style Index returns relative to Value

^{Source: Wilshire}

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^{Index 15303321 E0922}

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