Looking back at Equity Factors in Q2
16 AUG, 2022
By Pierre Debru from WisdomTree
Markets in Q2 2022 continued to suffer from entrenched inflation and aggressive rate hikes from central banks. They also reacted to the slowdown of the global economy and the increased risk of a recession in developed economies.
These changing market conditions impacted equity factors differently. In this instalment of the WisdomTree Quarterly Equity Factor Review , we aim to shed some light on how equity factors behaved in Q2 2022 and how this may have impacted investors’ portfolios.
Over July, central banks aggressive tightening continue to slow down the global economy, raising the probability of a global recession.The impact of this slowdown has been clear with rate hike expectations lowering leading to a factor rotation in favor of quality and size. Looking forward, uncertainty around recession and economic growth will continue to rise. Investors are facing the need to balance their portfolio between building wealth over the long term and protecting their portfolio during economic downturns. This environment could therefore favour high dividend and quality stocks.
Performance in focus: high dividend continues to lead, but min vol is catching up In the second quarter of 2022, equity markets suffered from a deep drawdown, leading to the worst first half year in decades. The MSCI World lost -16.2%. Unusually, the US underperformed European markets with -16.9% versus -9%. Emerging markets suffered as well with -11.4% Q2 2022 factor performance continued to be driven by inflation surprises on the upside and the hawkish stand of developed countries' central banks.
However we also saw two new entrants this quarter with heightened volatility and the fear of recession rocking markets further. Faced with such a brutal landscape, some factors continued to do well, and some did not:
Figure 1: Equity factor outperformance in Q2 2022 across regions
Source: WisdomTree, Bloomberg. 31st March 2022 to 30th June 2022. YTD performance figures are sourced from Bloomberg from 31st Dec 2021 to 30th June 2022.Full index definitions can be found below. Historical performance is not an indication of future performance and any investments may go down in value.
Looking at the outperformance of factors over the last six months, we notice that:
Figure 2: Year to date outperformance of equity factors in developed markets
Source: WisdomTree, Bloomberg. 31st December 2021 to 30th June 2022. Full index definitions can be found below. Historical performance is not an indication of future performance and any investments may go down in value.
It is worth noting that since the end of June, markets expectation of a recession has continued to grow. This has led to a revision downward of the expectation on future rate hikes. Equity factors have reacted to this change pretty strongly, with quality and size taking the lead for that month while value and high dividend released some of their performance. This rotation has been particularly strong in Europe where economic predictions are the most dire. Having said that, the performance difference in the first 6 months were so high that the full year to date picture remains similar.
Valuations continue to come down across the board
In Q2 2022, valuations continued to decrease across the board for factors. Momentum and quality saw the largest drop in valuations in all geographies. On a relative basis, high dividend stocks and value stocks got more expensive versus the market on the basis of lower drop in their price to earning ratios.
Figure 3: Historical Evolution of Price to Earnings ratios of equity factors
Source: WisdomTree, Bloomberg. As of 30th June 2022. Full index definitions can be found below. Historical performance is not an indication of future performance and any investments may go down in Value.
The re-opening trade in 2021 has evolved into the ‘recession trade’ in 2022, owing to a tardy start to the hiking cycle by central banks. Their aggressive tightening plan is slowing the global economy, raising the probability of a global recession. Leading economic data (LEI) shows economic momentum is fading quickly. The impact of this slowdown has been clear in July with rate hike expectations lowering leading to a factor rotation in favor of quality and size. However, this risk of recession only adds to the uncertainty for investors. They need to carefully balance the risk in their equity allocation. All-weather assets continue to be best positioned, delivering balance between building wealth over the long term whilst protecting the portfolio during economic downturns. This environment could therefore favour high dividend and quality stocks.
