40 BARRON’S September 16, 2019
FACTORS nBy Evie Liu
The Great Rotation
Value stocks show signs of a comeback—at long last
IT MUST BE A PRETTY DULL WEEK IN THE
stockmarketifeveryone’stalkingabout
factors.
Stock groups with different charac-
teristics—so-called factors—had been
runninginverydifferentdirectionsover
the past few months. The market’s best
performers, known as high-momentum
stocks, and the least volatile, known as
low-vol stocks, had outperformed as
investorsshunnedthecheapest,smaller,
more-volatile ones. In July, the perfor-
mance gap between the two sides was
wider than at any point in market his-
tory,accordingtoJ.P.Morgandata,even
surpassing the spread during the tech
bubble in the late 1990s.
Nowthattrendhassharplyreversed.
FromSept.5toSept.10,theMSCIUSA
MomentumIndexdropped3.1%,andthe
S&P 500 Low Volatility index fell by
1.1%,evenasthebroaderS&P500index
remained largely flat.
Valueandsmall-capitalizationstocks,
meanwhile,havesprungtolife.TheRus-
sell1000ValueIndexgained1.6%,while
the small-cap Russell 2000 jumped
2.1%—even as the Russell 1000 Growth
index declined 1.4% and the large-cap
Russell 1000 rose by only 0.1%.
Don’t be surprised if this rotation
remainsinplaceuntilatleastOctober—
and perhaps even longer than that.
What was behind the sudden shift?
Beforelastweek,investorsappearedto
be betting that bond yields would fall.
Andforawhile,thattradeworked.Both
momentumandlow-volatilitybasketsare
loadedwithdefensivestocksthattendto
riseasyieldsfall—asignalthatbondin-
vestors are losing faith in the economy.
Nolonger.The10-yearTreasuryyield
rosefrom1.461%onSept.3to1.733%on
Sept.10,whiletheyieldcurve,whichhad
been inverted, steepened. “The extreme
factormovesweareseeingintheequity
marketaredrivenbyactivityinthefixed-
incomemarket,”NomuraInstinetstrate-
gist Joseph Mezrich wrote on Tuesday.
There’sagoodreasonforthat.Asin-
vestorsturnedmoredefensivethisyear,
low-volatility stocks have attracted sig-
nificantassetsacrossbothretailandin-
stitutionalplatforms.Andthathasmade
them expensive. Christopher Harvey at
WellsFargonowrecommendsthatinves-
torsreducetheirexposuretolow-volatil-
itystocks,astarkcontrasttohisposition
at the beginning of the year.
“About a year ago, we talked about
low-volstrategiesbeingoneofthemost
unlovedandunderappreciatedstrategies
in the marketplace,” wrote Harvey on
Tuesday.“However,thestyleisnolonger
thetechnicallyoversoldandunderowned
strategy it was in years past.”
As we’ve noted, the momentum bas-
ket has recently shifted from being a
group of fast-growing companies to in-
cludemanyofthemarket’sleast-volatile
stocks.Thosearealsotheonesmostde-
pendent on yields going down, explains
Bernstein analyst Sarah McCarthy.
“Themarketwaspayingforcontinu-
ity of the current macro trend, rather
thanpayingforgrowthcharacteristicsof
stocks,”shewrote.“Themoveupwardin
yields over the past few days seems to
have triggered this factor rotation.”
The question now: Does the reversal
have staying power? To answer it, we
needtoconsiderwhatcouldcauseinves-
torstoagainprioritizesafetyoverallelse.
For J.P. Morgan strategist Marko
Kolanovic, that would be a failure of the
trade discussions between the U.S. and
ChinascheduledforOctober.Ifthenego-
tiations fail, the recent moves could well
be unwound. If progress is made, how-
ever,itwillbuythemarketmoretimefor
theglobalmonetaryandfiscalstimulusto
take effect—and for the rebound to con-
tinue.Beforethat,thereisnowawindow
ofatleastthreeweeksforbondyieldsto
continue to rise and for stocks to move
higher,especiallyafterPresidentDonald
Trump delayed a rise in tariffs to mid-
October.
Onewaytoplaythecurrentrotation
infactorsistobuythesmall-capcompa-
niesintheenergyandmaterialssectors,
Kolanovic says. The group has been hit
particularly hard since it was at the
nexusofsellingbylow-volatility,growth,
andmomentuminvestors.“Normalization
oftheseextremeconditions,andrelated
feedback loops, may create unusually
high upside in this market segment,”
wrote Kolanovic in a Tuesday note.
At least until the next rotation.
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