We covered in our last blog post how the v-shaped recovery appeared nearly complete through the first half of 2020. Despite a staggering 34% decline, investors poured back in as the “Fed put” took hold. While you might think the pandemic’s shock to the market might have returned it to a more stable position, we’ve actually seen a few metrics in the Intech Equity Market Stress Monitor® shift significantly over the past 12 months in ways that represent potential market risk of one kind or another.
Capital concentration, a measure of how capital is distributed between stocks, steadily increased (capital moved toward the larger-cap stocks) in the second quarter. This effect was especially prevalent in the U.S., where the S&P 500 is now at the 87th percentile of capital concentration – an extreme level based on the past 40 years. As seen in the figure below, this metric ebbs and flows over time, but does not tend to stay near historical extremes for too long.
Correlation of returns, a measurement of the similarity in stocks’ absolute returns, is also approaching historical highs in global equity markets. This metric reflects potential groupthink and heightened systematic risk as stocks’ returns within different equity indexes begin to move in similar directions.
As stocks have been moving more in tandem, the dispersion of returns (also known as cross-sectional volatility) has also increased in major equity indexes, reflecting greater differentiation between stocks’ excess returns relative to their index. This change has the potential to increase the impact of stock-specific effects in actively managed portfolios.
The combination of these moves in market structure can be more difficult for active managers because of the lack of diversification potential. The good news: we’ve been here before. While levels near the margins can persist for a short while, they have reverted to median levels eventually. While aspects of equity markets during the first half of 2020 have been challenging for managers with diversified portfolios, we believe this approach is still most prudent over a full market cycle.
See for Yourself
We’ve only scratched the surface in these observations. Take a deeper look with the Intech Equity Market Stress Monitor®, which offers five market risk indicators and 21 global and regional equity benchmarks to explore interactively.
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