Renewed Covid worries spark flight to quality

By Mark Barnes, head of investment research (Americas), and Christine Haggerty, global investment research

Since mid-May, the global rallies in Value and Size factors have cooled, and Quality has staged a robust comeback. The catalyst: growing concerns that the rapid spread of the more virulent Delta variant and persistent supply-chain disruptions may delay or derail the global economic recovery.

The about-face has been particularly stark in the US, where Value has trailed the broad market by nearly four percentage points since its May 13 peak, while Quality has outperformed by 2.5 percentage points. The trend-following Momentum factor has also revived. Europe saw a similarly pronounced reversal in factor behavior.

The two time-series charts below depict the dramatic ebb and flow of Value and Quality performances since the initial surge in market euphoria last November, sparked by vaccine breakthroughs and ongoing aggressive crisis-fighting monetary and fiscal stimulus efforts. Recent moves reflect shifts to more nuanced expectations for economic growth, inflation and earnings in the year ahead.

The burst in reopening optimism last fall spurred a sharp rotation from Quality into Value, which is more heavily weighted to cyclically sensitive industries poised to profit from a reflating economy. The spike in long government bond yields earlier this year was also conducive to Value outperformance, by making the value of future earnings of the pricier, growth-heavy Quality factor less attractive.

Despite recent setbacks, Value remains a strong outperformer across markets for the 12 months, particularly in the UK, Japan and Asia Pacific.

Value factor  ̶  total returns relative to home market (LC, rebased)

The Quality rebound has come amid signs that the best of the economic and corporate-earnings recoveries may be behind us, as well as the discernibly more cautious tone in market sentiment. This has favored the stocks of strong, relatively reliable earnings growers (notably in technology and health care) that dominate the factor’s industry exposures. The sharp pullback in long bond yields since mid-March has also been a tailwind.

This comeback gathered steam in June and July, restoring Quality to outperformance status for the 12 months in the UK, Europe, emerging markets and nearly so in the US − though it still lagged in developed Asian markets.

This post first appeared on August 5 on the FTSE Russell blog.

Photo Credit: Steve Higgins via Flickr Creative Commons


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