As the Roads Divide in 2022, One Exchange Makes All the Difference

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(Bloomberg) – The worst year for stock bulls since 2008 will also be remembered as the one in which the prevailing investment strategies drifted furthest apart in two decades.

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Diverging fortunes have hit the most famous US stock indexes, with the S&P 500 losing almost 20% annually, more than double that of the Dow Jones Industrial Average. A more specific comparison involves style categories – value and growth – with the latter trailing the former by a factor of 3 and losing in percentage by the most since 2000.

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It’s been the refrain of quantitative bulls for years: value was due to a win. In 2022, this happened – at least in relative terms – due to a confluence of anti-growth forces ranging from rising bond yields to tightening Federal Reserve. Things got tough for the supercharged megacaps that dominated the decade following the financial crisis. In their place came energy, insurance and food stocks.

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« 2022 was the year the tide went out and we could see who was swimming naked, » said Andrew Adams of Saut Strategy. « This is the first year in a long time that it’s been necessary to do more than just buy the dips and hold them to make money. »

Success in 2022 came down to one decision in terms of portfolio construction: immunize against interest rate sensitivity. It was a request made about a year ago by Mahmood Noorani, managing director of London-based analytical research firm Quant Insight, from a client worried about growth and credit risk. At Noorani’s behest, the portfolio manager cut once-hot names like Meta Platforms Inc. and PayPal Holdings Inc. by 25%, and increased by the same amount in companies such as Coca-Cola Co. and Shell Plc .

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Four months later, the redesign paid off: a 4 percentage point improvement in returns over what would have happened had such adjustments not been executed.

The case study highlights the main theme of 2022: when the path of inflation and Fed policy become the dominant force in the market, everyone becomes a macro trader. Heeding major economic trends could eclipse stock picks again in the new year, as China has just removed the last of its Covid curbs as the recession debate heats up in the United States.

Fund managers are « finally accepting that the world we find ourselves in means that if they want to keep their alpha on a single stock and all the fundamental research they do, then the macro comes along and of course blows them up more and more more regularly, » Noorani said in an interview. « In order to get through those macro periods so they can actually reap that alpha, they need to be macro aware. »

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With inflation and Fed policy dominating news feeds, investors have faced an all-or-nothing market where the fundamentals of individual companies recede into the background. Stock market moves, one day up and the next day down, swept across the market like storms, as inflation paranoia alternated with optimism that the economy can weather the Fed’s battle against she. During 83 separate sessions in 2022, at least 400 members of the S&P 500 have moved in the same direction, a rate that exceeds in all but one year since at least 1997.

From commodities to bonds to currencies, nearly every asset was at the mercy of events such as Russia’s invasion of Ukraine and the Bank of England’s dramatic intervention in government bonds. State. A measure of asset correlation tracked by Barclays Plc nearly doubled this year through August, putting it among the highest levels in 17 years.

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In this rate-obsessed world, a notable trend has emerged: stocks have moved in tandem with Treasuries and against the US dollar. In fact, it’s happened on 28 different weeks this year, a frequency not seen since at least 1973.

While the lingering asset-to-asset relationship has been a boon for trend-following quantitative funds, it has hurt stock pickers, especially those holding tight to former darlings of technology and growth.

« If we’re all being honest, the people who did very poorly this year did poorly because they weren’t really aware of what was going on overall with interest rates and this new paradigm shift, » said Matt Frame, a partner. at Bornite Capital Management, a stock-picking hedge fund that took up short positions against tech stocks and reduced equity exposure in anticipation of a hawkish Fed. « And those who have done pretty well this year haven’t really seen it coming, but have been able to adapt to this kind of changing landscape. »

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The danger of ignoring central bank action is best illustrated by the timing of the S&P 500’s worst performance in 2022. The index’s five largest weekly declines occurred immediately before or around a Fed meeting.

According to Quant Insight’s Noorani, more and more pros are recognizing the importance of mastering the impact of macroeconomic forces on market performance. The firm’s macro risk product – which offers analysis of the relationship between asset prices and more than 20 risk factors such as liquidity and rate expectations – brought in a dozen new clients this quarter after having partnered with Goldman Sachs Group Inc. this summer. This represents an increase from a total of four additions in the previous nine months.

As we approach next year, growth in gross domestic product has become a dominant factor for the stock market, according to the company’s model.

“The risk for 2023 is recession and a turning point in the credit cycle,” Noorani said. « The focus for us now is to go out to our clients and prospects and encourage them to consider their exposure to global GDP growth and credit spreads. »