US large-cap equities rode on momentum as 2020 opened until the market peaked in mid-February, then saw US investors flock to defensive factors in recent weeks, according to new factor analysis from global index provider FTSE Russell.

FTSE Russell examined total returns for the US large-cap Russell 1000® Index through the lens of the six major market factors—Value, Quality, Size, Yield, Low Volatility and Momentum—for 2020 leading up to the market peak, and in the time period since the market peak. Factor analysis shows that Momentum led US. large caps at the start of 2020 up to mid-February while, in the period since mid-February, investors have gravitated most toward the defensive-oriented Quality and Low Volatility factors.

In addition, defensive-oriented stocks have cushioned the blow somewhat in the recent market selloff, with the Russell 1000 Defensive Index losing 19.9% since February 19 as compared to a 26.2% loss for the Russell 1000 Dynamic Index.

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By Philip Lawlor, managing director, Global Markets Research

The outperformance of US large caps over their small-cap peers that began last June persisted through the March 2020 turmoil, underpinned by the extreme investor run for safer ground. The Russell 1000 fell 20.2% in Q1 2020, versus a drop of 30.6% for the Russell 2000. While both indexes enjoyed sharp rebounds in late March, only the Russell 1000 is back in positive territory for the longer term (up 4.9% since January last year). The Russell 2000 remains deeply in the red (down 12.9% for the same period).

Russell 1000 vs Russell 2000 (Rebased, TR, USD) – large caps back in the black

Source: FTSE Russell. Data as of March 31, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.

Differences in sector exposures explain much of this performance gap. The 10 biggest negative contributors accounted for 19.4% of the Russell 2000’s Q1...

By Philip Lawlor, managing director, Global Markets Research

Call it a case of first in, first out: Despite the distinction of being the initial epicenter of the now global coronavirus outbreak, China's equity market suffered far less than both the emerging and developed indexes in the March downdraft and for the year so far.

In March, the FTSE China Index fell 7.0%, significantly outperforming the declines of 14.1% for the Emerging Markets Index and of 12.7% for the FTSE All-World Index. China’s resilience is particularly striking when compared with the significant losses of its peers among the largest emerging markets—the so-called BRICs—with Brazil, Russia and India dropping between 22% and 29%.

Select global equity total returns (%) – China sustains far less damage in market turmoil

Source: FTSE Russell. Data as of March 31, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.

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As investors address significant issues and questions around global equity markets based on reaction in recent weeks to the growing global pandemic, our experts shared insights and updates to help provide perspective.

In a recent webinar for clients and the news media entitled "The state of the global equity markets through the lens of FTSE GEIS," our managing director of global markets research, Philip Lawlor, shared FTSE Russell’s current market perspective:

“The key question for markets and investors right now is, ‘How long will this last?’ And while we have certainly seen a quantum event for the global equity markets in terms of the size and speed of the drawdown, potential good news is that policymakers are responding quite quickly and quite forcefully with monetary stimulus. However, fiscal policy stimulus, such as we have seen recently in the US and UK, will be more meaningful going forward to deliver the recovery.”

 

“In terms...

number of issues par value market value market weight coupon average life credit quality different types of yield (e.g. yield-to-maturity, yield-to-worst) different measures of duration (e.g. modified duration, effective duration) different types of spreads (e.g. OAS to Treasury, OAS to Swap)

number of issues par value market value market weight coupon average life credit quality different types of yield (e.g. yield-to-maturity, yield-to-worst) different measures of duration (e.g. modified duration, effective duration) different types of spreads (e.g. OAS to Treasury, OAS to Swap)

By Philip Lawlor, managing director, Global Markets Research

Examining the industry-weighted contributions to the total return regionally since the market peaked on February 19 highlights that financials have been the largest negative contributors across most regions.

In the US, the underperformance of the large technology sector has weighed heavily on the overall return of the market. Elsewhere, industrials and consumer goods have also contributed significantly to overall losses.

By contrast, investors have sought the relative safety of the more defensive utilities and telecoms, reflected in the chart by their small negative contributions..

Industry-weighted contributions to total returns since February 19, 2020

Source: FTSE Russell. Data as of March 24, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.

Drilling into the biggest negative industry contributors to returns...

By Philip Lawlor, managing director, head of Global Markets Research

Not surprisingly, factor performances have exhibited the same desire for safety that has gripped other corners of the global capital markets this year. Amid the widespread losses since equity markets peaked in mid-February, defensive Quality and Low Volatility factors have strongly outperformed riskier Value and Size, accelerating trends in place for the past 12 months (Chart 1). 

The virus outbreak has cut a particularly deep gulf between defensive and riskier factor performance in the US (Chart 2). The stocks of US companies with relatively reliable and more stable profitability and lower debt burdens have suffered far smaller declines than those of less well-endowed companies, catapulting Quality, Profitability and Low Vol leadership over Value and Size. Our analysis found similar stark divergences in factor performance in Europe, Japan, Asia Pacific and Emerging Markets.

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By Philip Lawlor, managing director, Global Markets Research

US investors have been licking their wounds from their overseas returns as the weakness in non-US currencies have significantly affected returns. The chart below, which compares global equity returns since the peak in global equity performance on February 19, highlights some divergence in performance between local currency and US dollar returns.

As the table shows, the worst performing developed equity markets to date in local currency terms included Australia and in Europe, Italy, Spain and France, all of which lost up to 32% in returns. For a dollar investor, however, the UK, Canada and Norway ranked among the worst performing markets. Australia retained its overall position as the worst performing market, seeing its returns further reduced to -40.9% in US dollar terms from the currency impact. By contrast, both Japan and Switzerland outperformed the other countries, in both local and dollar...

By Philip Lawlor, managing director, Global Markets Research

Looking at the performance of the Russell 1000 Index and the Russell 2000 Index over the last six months shows that both markets have been badly impacted by the coronavirus sell-off, with the Russell 1000 incurring losses of 29.7% compared to 37.3% for the Russell 2000 since the peak in February 19.

Russell 1000 vs Russell 2000 (Rebased, TR)

Source: FTSE Russell. March 19, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

The difference in performance between US large and small companies can be seen by looking at their relative performance over the last twelve months. What the chart below highlights is the sheer scale of the outperformance of the Russell 1000 vs Russell 2000 in response to the virus outbreak but what can also be observed is the loss of momentum of that the outperformance in the last few days.

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By Philip Lawlor, managing director, Global Markets Research

With global equities having lost up to 36% in performance since their peak on February 19, what does this mean for equity market valuations? The latest 12-month forward PE ratios show that the US has returned to levels last seen during the 2018 correction, while those of other markets have reached valuations close to 2012 levels.

There is a clear risk, however, that equity markets could be on the cusp on a "value trap" as the "E" in the PE still needs to be adjusted.

Regional Relative 12m Forward PE Ratios-Longer Term

Source: FTSE Russell, Refinitiv. March 16, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Examining the valuation of equities to bonds by comparing equity earnings yield to bond yield (the Fed model) shows that equities have moved back to levels not seen since 2012.

Earnings yield minus bond...

By Philip Lawlor, managing director, head of Global Markets Research

Consensus EPS forecasts are stuck in limbo as analysts struggle to predict the unpredictable amid a fast-moving health crisis and a scarcity of hard data. Though estimates continue to point to a robust global earnings recovery this year and next, no one believes them.

But bond-market signals and history can help dimension what’s coming.

Extrapolating from longstanding predictive relationships, the recent break in 10-year US Treasury yields to all-time lows is signaling a sharp contraction in the US ISM Manufacturing Index, a key leading economic indicator, to around 40 from the modest expansionary reading in February. As Chart 1 shows, these ISM levels correspond to a nearly 3% drop in US GDP—and are on a par with those preceding the past two recessions.

There is also a historically close relationship between shifts in the US ISM Manufacturing Index and six-month revisions...

By Philip Lawlor, managing director, head of Global Markets Research

Consensus EPS forecasts are stuck in limbo as analysts struggle to predict the unpredictable amid a fast-moving health crisis and a scarcity of hard data. Though estimates continue to point to a robust global earnings recovery this year and next, no one believes them.

But bond-market signals and history can help dimension what’s coming.

Extrapolating from longstanding predictive relationships, the recent break in 10-year US Treasury yields to all-time lows is signaling a sharp contraction in the US ISM Manufacturing Index, a key leading economic indicator, to around 40 from the modest expansionary reading in February. As Chart 1 shows, these ISM levels correspond to a nearly 3% drop in US GDP—and are on a par with those preceding the past two recessions.

There is also a historically close relationship between shifts in the US ISM Manufacturing Index and six-month revisions...

By Philip Lawlor, managing director, Global Markets Research

The coronavirus outbreak and subsequent market panic has turned investors into Donald Rumsfelds—attempting to price the ‘known unknowns’.

A few weeks ago—even as news of coronavirus spread—equity investors were celebrating as stocks powered to new highs, driven by the performance of US tech stocks. Since then, every equity market has fallen, and fear-stricken investors have fled to haven assets.

Chart 1: asset class returns since February 19, 2020

 

Source: FTSE Russell, Refinitiv. March 9, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

It is extraordinarily difficult to price an unprecedented event, but we can say is that the bond market has been more alert to the economic impact of coronavirus. In contrast to the initial resilience of equity markets, fixed income markets were quicker to treat the epidemic...

By Philip Lawlor, managing director, Global Markets Research

Despite the huge global stimulus response by policy makers, the downturn in global equity markets has remained sizable since they peaked on February 19. Unsurprisingly, being the new epicenter of the Covid-19 outbreak, European equities have taken the brunt of the sell-off, particularly in Italy and Germany, France and Spain. Scandinavian equity markets have held up comparatively better, with falls in the mid-twenties.

The US and UK have also registered returns of about -30%, as investors absorb the impact of increasingly drastic measures to combat the outbreak. Relative to other markets, Japanese equities have, so far, outperformed, as have emerging markets, although since their peak, losses remain substantial for both markets.

Regional equity market total returns since February 19, 2020

 

Developed market performance in more details

Emerging market performance...

By Philip Lawlor, managing director, Global Markets Research

Looking at the performance of the FTSE 100 Index and the FTSE 250 Index over the last 12 months shows that both markets have been badly impacted by the coronavirus sell-off; the FTSE 100 has incurred losses of 30.7% compared to 41.1% for the FTSE 250 since the February 19 peak.

FTSE 100 vs FTSE 250 (Rebased, TR)

Source: FTSE Russell. March 19, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

The difference in performance between UK large and small companies can be seen by looking at their relative performance over the last 12 months and comparing this against sterling. What the chart highlights is the inverse relationship between sterling and the performance of the FTSE 100 Index. As the chart below shows, the severe depreciation of sterling has had a devastating effect on the performance of the FTSE 250 Index, whose...

Join FTSE Russell’s market specialists for a 30-minute webinar, during which they will share their analysis of global equity and bond markets, and review current market drivers, such as valuation, earnings and financial conditions, all within the context of the coronavirus pandemic.

Key discussion points:

Integrating climate change issues into listed real estate portfolios Fong Yee Chan (FTSE Russell), Isabelle Bourcier (BNP Paribas Asset Management) [[ webcastStartDate * 1000 | amDateFormat: 'MMM D YYYY h:mm a' ]] 60 mins

By Philip Lawlor, managing director, head of global markets research

Assessing how damaging the coronavirus epidemic will ultimately be for the global economy remains challenging.

The viral outbreak has cast a shadow over global growth expectations, which had been improving in recent months thanks to coordinated central-bank stimulus efforts and the US-China trade truce. Notably, leading indicators, particularly in manufacturing, had begun showing tentative signs of recovery.

This fledgling rebound has been mirrored in consensus 12-month forward GDP estimates, which had also appeared to be stabilizing after the sharp deterioration from early 2018 peaks.

 

Yield curves resume flattening

Bond markets have largely interpreted the outbreak as a disinflationary shock: With the sharp decline in China-dependent oil and copper prices, breakeven inflation expectations have given back much of their Q4 gains, resuming the downtrend...