“Transitory” inflation is the talk of Wall Street as pundits parse its definition and potential consequences. At Intech, we monitor a set of equity risk metrics daily that we expect to be transitory as they typically revert to their mean. But when they change direction rapidly, consequential market moves potentially follow. We haven’t seen those types of reversals yet, but some of the metrics that comprise the Intech Equity Market Stress Monitor® are stretched enough to suggest caution in both developed and emerging markets.
High Capital Concentration
The Intech Equity Market Stress Monitor continues to indicate high levels of capital concentration in U.S. and global markets. It is exceptionally high in U.S. large-cap growth-oriented markets. Market concentration remains a vital sign of potential market stress and further evidence that concerns are building regardless of the reason.
If we look at non-U.S. developed equity markets, capital concentration for the MSCI EAFE and MSCI Europe is at the opposite end of the spectrum in both cases. This outcome has very different implications for non-U.S. developed markets should capital concentration increase.
Declining Market Breadth
While not officially part of the Intech Equity Market Stress Monitor, market breadth is a first cousin to capital concentration. It indicates the relative change of advancing to declining securities in the market. Market breadth fell notably in the second quarter and the implications of this decline are less clear.
We have seen several new closing highs in the S&P 500 this year, but under the surface, only 38% of stocks outperformed in the second quarter. A significant drop from the prior two quarters. It’s even more anemic in the growth universe, where only 26% of stocks outperformed during the second quarter – levels lower than the second and third quarter of last year when U.S. mega-cap growth stocks led the market during the equity recovery. The second quarter was a repeat of the same tired story over the past several years, mega-cap growth stocks leading the market, which tends to be a challenging environment for diversified U.S. large-cap active management.
High Correlation of Returns
A key component of the Intech Equity Market Stress Monitor is the correlation of returns which measures the market-weighted average pair-wise correlation of stocks in the index. We’re seeing further signs of stress in the high levels of stock correlations. These have increased sharply over the last 12 months and remain close to all-time highs. It indicates a heightened level of systematic risk in equity markets, meaning that beta predominately explains equity returns.
The equity market gains from last year’s bottom have been characterized by a strong rally in the highest beta stocks, which remain elevated as seen by the payoff to the high beta factor.
Of course, given the rally in higher beta stocks, an allocation to defensive stocks could have strategic and tactical merit for a multi-asset portfolio. We get a sense of how stretched the performance is for defensive indexes, given the difference in the rolling 12-month return between Minimum Volatility Indexes and their cap-weighted counterparts.
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Look beyond conventional narratives and risk metrics. Each quarter, Intech examines equity market stability around the world through the lens of the Intech Equity Market Stress Monitor ― a collection of five reliable metrics of market strain that can help you gain additional insight to market risk regimes.
The information expressed herein is subject to change based on market and other conditions. The views presented are for general informational purposes only and are not intended as investment advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation, or sponsorship of any company, security, advisory service, or fund nor do they purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. This information should not be used as the sole basis for investment decisions. All content is presented by the date(s) published or indicated only, and may be superseded by subsequent market events or other reasons. Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal and fluctuation of value. Information that is based on past results or observations is not necessarily a guide to future results, and no representation or warranty, express or implied, is made regarding future results.
