The 2022 Bear Market Factor NarrativeBy OSAM Research Team
Several quarters ago, we incorporated a new machine learning tool to evaluate factor drivers in performance regimes. We distilled the post-COVID vaccine environment into three regimes—an early reflationary period that gave way to a period of uncertainty, which was followed by a reaction to the FOMC’s November 2021 hawkish pivot and a bear market.
At the outset of each regime, a classification algorithm segments the market into groups based only on their fundamental characteristics. We then tracked performance of the groups to measure the spread between the highest and lowest performing. Below is an update on the three periods, the core macro driver that influenced the market, the characteristics of top and bottom performing groups, and the performance spread between the two:
The most important determinants of performance were Value and Shareholder Yield across the regimes and universes we monitor. Portfolios oriented towards cheap names with strong Shareholder Yield (dividends + buybacks) did quite well throughout. Momentum has generally struggled, which is not a surprise given the rotations that have occurred, but improved in the 2nd quarter.
When you dig into the results of the bear market regime we are currently in, a few trends have emerged:
- Soon after the FOMC’s Hawkish pivot in November, unprofitable stocks with negative earnings were harshly punished. They tend to reside on the growth side of the ledger, i.e. expensive, partially explaining growth’s fall from grace around that time.
- After the market peaked at the start of 2022, two of our quality themes—Financial Strength (balance sheet leverage and reliance on outside sources of financing) and Earnings Quality (use of non-cash items in reported earnings)—became the most important factor determinants of performance.
- Stability (low volatility in corporate fundamentals like revenues and cash flows) rose to be the most important factor in explaining the variability in returns in the 2nd quarter. Said another way, stocks with stable underlying businesses tended to do particularly well, while those with volatile fundamentals tended to struggle.
Market internals seem to be telling a clear story. As easy monetary policy came into question, stocks benefitting most from monetary largess—those with no earnings—were quickly de-rated. The market then placed preference on appropriate levels of leverage and cash-driven earnings. Finally, its placed greater preference on stocks with more reliable (less volatile) fundamentals in the face of tremendous uncertainty about the future.
One theme that falls at the cross-section of these themes is Dividend Growth. Stable dividend growers historically offer downside protection in volatile and down markets given the more conservative posture, stable fundamentals, and income growth that generally exceeds the rate of inflation.
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CANVAS® is an interactive web-based investment tool developed by O’Shaughnessy Asset Management, L.L.C. (“OSAM”) that permits an investment professional (generally a registered investment advisor or a sophisticated investor) to select a desired investment strategy (the “Strategy”) for the professional’s client. At all times, the investment professional, and not OSAM, is responsible maintaining the initial and ongoing relationship with the underlying client and rendering individualized investment advice to the client. In addition, the investment professional and not OSAM, is exclusively responsible for:
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