Looking back at Equity Factors in Q1 with WisdomTree
2022 opened with a sharp decline. The Ukraine War added further uncertainty to an already complex situation with entrenched inflation and upcoming rate hikes. In this installment of the WisdomTree Quarterly Equity Factor Review1, we aim to shed some light on how equity factors behaved in Q1 2022 and how this may have impacted investors’ portfolios.
- Value and High Dividend dominated in most regions.
- Pushed by increasing volatility and nervousness in the market, Min Volatility followed closely behind.
- Momentum and Size suffered mostly over the quarter, delivering underperformance across regions.
- Quality strategies delivered mixed results depending on their portfolio’s overall valuation.
Looking forward, uncertainty continues to rise, being economic or geopolitical. Investors face a trifecta of worries: rate hikes, inflation and volatility. Those market conditions should continue to favour value, high-dividend and quality stocks.
Performance in focus: Value and High Dividend lead the march
In the first quarter of 2022, equity markets took stock of a changing economic and geopolitical landscape. This led to a sharp decline in the first two months of the year, and despite a rebound in March, the MSCI World lost -5.2%. Unusually, the US and European markets delivered the same performance of -5.3%. Emerging markets lagged, impacted, in part, by the zeroing of most Russian stocks at the start of the war in Ukraine.
Q1 2022 factor performance has been driven by high inflation, the upcoming rate hike cycle and the Ukraine War. Faced with such a brutal landscape, some factors did well, some did not:
- Value and High Dividend dominated in most regions. They are the only factors that managed to outperform in all four geographies over the quarter.
- Pushed by increasing volatility and nervousness in the market, Min Volatility followed closely and ended up winning in emerging markets. Counterintuitively, it is in Europe that it did the worse.
- Momentum and Size suffered mostly over the quarter, delivering underperformance across regions.
Quality is an interesting case. The MSCI Quality indices used here as a proxy for the factor have suffered over the quarter, underperforming by 2 or 3% in developed markets. However, in this instance, the definition of quality and the criteria used would have hugely impacted the result. Quality, left unattended, tends to tilt toward growth (investors pay for quality, after all). This is the case for the MSCI indices and explains the underperformance in a Value-dominated market. Other ways to create quality strategies, focusing on profitability and dividend growers, for example, have fared better over the period.
Looking deeper into factors’ behaviour over the quarter, we notice two distinct periods. In January and February, markets' main concerns focused on rate hikes and inflation. In January, we saw expectations of the number of hikes by the Federal Reserve skyrocket. This led to a focus on low duration equities, away from high duration equities. Looking through holdings in different factors, this translates into tailwinds for Value and High-Dividend and quite large headwinds for growth. This is what we observe in the monthly returns, with Value and High dividend outperforming in both months. However, March saw a slight shift in perspective, with markets starting to worry about the effect of rate hikes on growth and the recovery. The inversion of the yield curve put an emphasis on such worry, and this led to the continued increase in market volatility. Therefore March saw a turn towards more risk-off assets with Min Volatility and Quality benefitting while more cyclical factors like Size and Value suffered more.
Factors, inflation and rate hikes
Inflation is back after a 15 year, if not 30 year, hiatus. In some way, markets and investors have forgotten how equities behave in an inflationary environment. As always, History is a very good teacher.
Figure 3 illustrates the average monthly outperformance of US equities organised by factor pairs in periods of above-average or below-average inflation. Historically, it is quite clear that
- High-quality stocks have created most of their historical outperformance compared to low-quality stocks in periods of higher inflation
- Similarly, value stocks, high dividend stocks and momentum stocks have also created more outperformance in periods of above-average inflation but less aggressively than quality
Implied duration is an interesting indicator of potential resistance to a rate hike cycle. Figure 4 exhibits the duration of equity stocks using a concept called ‘implied equity duration’, which measures the sensitivity of a stock just like the Macaulay duration measures interest rate sensitivity of bonds. It applies an extended duration calculation formula using forecasted cash flows for the company where cash flows are predicted using earnings and changes in Book Value. Stocks are then organised in equal-weighted quintiles depending on their estimated forward dividend yield or forward price to earnings ratios (“P/E”). We observe that:
- The quintile with the highest forward dividend stocks has the lowest duration on average, and the relationship is monotonic, with duration decreasing as the dividend yield increases
- The quintile with the cheapest stocks has the lowest duration on average, and the relationship is monotonic, with duration increasing as the P/E increases
In line with recent performance, this analysis points to high dividend and value stocks as being resistant to a scenario of rate hikes.
Valuations continue to come down across the board
In Q1 2022, valuations have decreased almost across the board for factors. Only high dividend stocks in Europe and emerging markets and value stocks in the US have seen a slight increase in price to earnings ratios. Size and Momentum have seen the sharpest drop.
Looking forward, uncertainty continues to rise, being economic or geopolitical. Inflation, pushed by commodity prices themselves stoked by the Ukraine War, shows no sign of slowing down. In response, Central Banks are turning increasingly hawkish, with the Federal Reserve planning to hike and reduce their balance sheet aggressively at the same time. This leaves investors with a triple worry: rate hikes, inflation and volatility that should continue to favour value, high-dividend and quality stocks.
World is proxied by MSCI World net TR Index. US is proxied by MSCI USA net TR Index. Europe is proxied by MSCI Europe net TR Index. Emerging Markets is proxied by MSCI Emerging Markets net TR Index. Minimum volatility is proxied by the relevant MSCI Min Volatility net total return index. Quality is proxied by the relevant MSCI Quality net total return index.
Momentum is proxied by the relevant MSCI Momentum net total return index. High dividend is proxied by the relevant MSCI High Dividend net total return index. Size is proxied by the relevant MSCI Small Cap net total return index. Value is proxied by the relevant MSCI Enhanced Value net total return index.
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
- Value and High Dividend dominated in most regions.
- Pushed by increasing volatility and nervousness in the market, Min Volatility followed closely behind.
- Momentum and Size suffered mostly over the quarter, delivering underperformance across regions.
- Quality strategies delivered mixed results depending on their portfolio’s overall valuation.
Looking forward, uncertainty continues to rise, being economic or geopolitical. Investors face a trifecta of worries: rate hikes, inflation and volatility. Those market conditions should continue to favour value, high-dividend and quality stocks.
Performance in focus: Value and High Dividend lead the march
In the first quarter of 2022, equity markets took stock of a changing economic and geopolitical landscape. This led to a sharp decline in the first two months of the year, and despite a rebound in March, the MSCI World lost -5.2%. Unusually, the US and European markets delivered the same performance of -5.3%. Emerging markets lagged, impacted, in part, by the zeroing of most Russian stocks at the start of the war in Ukraine.
Q1 2022 factor performance has been driven by high inflation, the upcoming rate hike cycle and the Ukraine War. Faced with such a brutal landscape, some factors did well, some did not:
- Value and High Dividend dominated in most regions. They are the only factors that managed to outperform in all four geographies over the quarter.
- Pushed by increasing volatility and nervousness in the market, Min Volatility followed closely and ended up winning in emerging markets. Counterintuitively, it is in Europe that it did the worse.
- Momentum and Size suffered mostly over the quarter, delivering underperformance across regions.
Quality is an interesting case. The MSCI Quality indices used here as a proxy for the factor have suffered over the quarter, underperforming by 2 or 3% in developed markets. However, in this instance, the definition of quality and the criteria used would have hugely impacted the result. Quality, left unattended, tends to tilt toward growth (investors pay for quality, after all). This is the case for the MSCI indices and explains the underperformance in a Value-dominated market. Other ways to create quality strategies, focusing on profitability and dividend growers, for example, have fared better over the period.
Looking deeper into factors’ behaviour over the quarter, we notice two distinct periods. In January and February, markets' main concerns focused on rate hikes and inflation. In January, we saw expectations of the number of hikes by the Federal Reserve skyrocket. This led to a focus on low duration equities, away from high duration equities. Looking through holdings in different factors, this translates into tailwinds for Value and High-Dividend and quite large headwinds for growth. This is what we observe in the monthly returns, with Value and High dividend outperforming in both months. However, March saw a slight shift in perspective, with markets starting to worry about the effect of rate hikes on growth and the recovery. The inversion of the yield curve put an emphasis on such worry, and this led to the continued increase in market volatility. Therefore March saw a turn towards more risk-off assets with Min Volatility and Quality benefitting while more cyclical factors like Size and Value suffered more.
Factors, inflation and rate hikes
Inflation is back after a 15 year, if not 30 year, hiatus. In some way, markets and investors have forgotten how equities behave in an inflationary environment. As always, History is a very good teacher.
Figure 3 illustrates the average monthly outperformance of US equities organised by factor pairs in periods of above-average or below-average inflation. Historically, it is quite clear that
- High-quality stocks have created most of their historical outperformance compared to low-quality stocks in periods of higher inflation
- Similarly, value stocks, high dividend stocks and momentum stocks have also created more outperformance in periods of above-average inflation but less aggressively than quality
Implied duration is an interesting indicator of potential resistance to a rate hike cycle. Figure 4 exhibits the duration of equity stocks using a concept called ‘implied equity duration’, which measures the sensitivity of a stock just like the Macaulay duration measures interest rate sensitivity of bonds. It applies an extended duration calculation formula using forecasted cash flows for the company where cash flows are predicted using earnings and changes in Book Value. Stocks are then organised in equal-weighted quintiles depending on their estimated forward dividend yield or forward price to earnings ratios (“P/E”). We observe that:
- The quintile with the highest forward dividend stocks has the lowest duration on average, and the relationship is monotonic, with duration decreasing as the dividend yield increases
- The quintile with the cheapest stocks has the lowest duration on average, and the relationship is monotonic, with duration increasing as the P/E increases
In line with recent performance, this analysis points to high dividend and value stocks as being resistant to a scenario of rate hikes.
Valuations continue to come down across the board
In Q1 2022, valuations have decreased almost across the board for factors. Only high dividend stocks in Europe and emerging markets and value stocks in the US have seen a slight increase in price to earnings ratios. Size and Momentum have seen the sharpest drop.
Looking forward, uncertainty continues to rise, being economic or geopolitical. Inflation, pushed by commodity prices themselves stoked by the Ukraine War, shows no sign of slowing down. In response, Central Banks are turning increasingly hawkish, with the Federal Reserve planning to hike and reduce their balance sheet aggressively at the same time. This leaves investors with a triple worry: rate hikes, inflation and volatility that should continue to favour value, high-dividend and quality stocks.
World is proxied by MSCI World net TR Index. US is proxied by MSCI USA net TR Index. Europe is proxied by MSCI Europe net TR Index. Emerging Markets is proxied by MSCI Emerging Markets net TR Index. Minimum volatility is proxied by the relevant MSCI Min Volatility net total return index. Quality is proxied by the relevant MSCI Quality net total return index.
Momentum is proxied by the relevant MSCI Momentum net total return index. High dividend is proxied by the relevant MSCI High Dividend net total return index. Size is proxied by the relevant MSCI Small Cap net total return index. Value is proxied by the relevant MSCI Enhanced Value net total return index.
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
