The unusual behavior of value, growth, and quality factors in November may come down to alarming inflation signals.
In the U.S., most value sub-factors, such as earnings yield and sales-to-price, outperformed the market by at least 1 percent in November. Sub-factors are essentially different ways of measuring style, size, and other premia.
Growth stocks, such as those measured by dividend, earnings, and sales, outperformed the benchmark by at least 50 basis points. Only a few sub-factors underperformed, including those measured by book-to-price (part of the value category), forecast growth (part of the growth category), and sales growth stability and low gearing (both part of the quality category), according to a recent report from the portfolio analytics company Investment Metrics.
“It’s not often that we see most value, growth, and quality sub-factors all outperform the markets, but in November they did just that,” according to Investment Metrics.
Damian Handzy, head of research and applied analytics at the research firm, said that value stocks took off in early 2021 as the economy started recovering from the pandemic. In the following months, value and growth stocks “played ping pong back and forth” as different market dynamics kicked in. The rise in interest rates, for example, had the potential to harm growth stocks more than value stocks. “Every month that interest rates rose significantly, value stocks did well,” he said. Then came November when both value and growth stocks outperformed benchmarks.
For Handzy, it was a signal of markets and investors confused by uncertainties, such as inflation, which hasn’t been an issue in 40 years in the U.S. There aren’t definitive answers to the impact of inflation on investors’ portfolios or solutions for how to hedge it. Indeed, with the monthly core inflation rate running above 4 percent for half a year, investors have come to believe that it will pose an acute challenge in 2022, despite the recent tapering announcement from the Federal Reserve.
Overall, in a month when major market indices were down, factors, long-term sources of returns, generated remarkable gains in developed regions, including the U.S., Europe, and Australia.
In November, the S&P 500 was down 83 basis points and the Dow Jones Industrial Average lost 3.73 percent. The MSCI Europe index and Australia’s All Ordinaries declined by 5.3 percent and 68 basis points, respectively. But stocks characterized by factors like value, growth, and quality outperformed the market around the world, according to Investment Metrics.
Factors have become a big business in asset management, whether as a lens through which to invest or as a way to analyze markets and portfolios for specific risks and exposures. Hot debates have also broken out over whether they can be trusted. With value, for instance, on a long cold streak up until recently, all kinds of investors have weighed in on the merit of factors.
In other developed economies, the performance of most factors also surpassed that of the overall market. In Europe, all sub-categories of quality stocks outperformed. Return on equity delivered 1.3 percent in excess returns. Quality measured by net profit margin generated 1.2 percent. In Australia, growth sub-factors demonstrated superior returns. Stocks with high dividend growth and earnings growth outperformed the market by 2.3 percent and 2 percent, respectively, the highest among all sub-factors across different regions.
Things look far different in emerging markets, where factors were “pointing in every different direction,” Handzy said. It’s a different way for the market to “express confusion.” Generally, different sub-factors converge to outperform or underperform. But in November there was no sign of any convergence. “Emerging markets have always been the wild west,” said Handzy. “You can make a killing or you can get slaughtered. They move much faster, and the analysts don’t have the same storyline.”
Handzy expects 2022 to be a volatile year, with value stocks becoming the dominant factor. He pointed to interest rate hikes, the continuing pandemic, and long-lasting inflation to be the major sources of uncertainty. All of which, he said, would drive investors to defensive positions. “2022 is looking to be a particularly dangerous year from a lot of perspectives,” he said.
