Market volatility vs Style volatility
Equity market volatility has been declining this year and has recently been below the long-run average. However, under the surface of the calm at the major index level, style rotation between Growth and Value has been extremely high.
The first chart below plots two rolling volatility series: the top section is the six-month annualized volatility of the S&P 500 index, while the bottom section is the volatility of the daily difference between the S&P 500 Pure Growth and Pure Value index returns. The dashed horizontal lines indicate the long-run average for each series.
Rotation, not risk-off
In response to client questions, we update some indicators we discussed back in January to address the debate about whether recent market action is indicative of a defensive shift (potential equity market top) or a rotation within equities that maintains a “risk-on” environment. Our current view, as it was in January, is that risk appetite remains broadly intact and the weight of the evidence suggests that we are seeing a rotation, not a “risk-off” environment.
Recent rally in “junk stocks” is not unusual
Financial headlines have been captivated recently by explosive behavior in certain “meme stocks” that have been the subject of intense speculation by online retail traders as well as some hedge funds. This has been accompanied by a general trend of outperformance by smaller, money-losing, heavily-shorted, and volatile stocks (sometimes referred to as “junk stocks”, similar to risky high-yield “junk bonds”).
Vaccine news brought record style rotation in stocks
The headlines on Monday (Nov. 9th, 2020) from Pfizer announcing favorable early results in their COVID-19 vaccine trials, while certainly welcome, clearly caught investors off guard. While the major indices were either up or flat on the day, there was a historic level of divergence within the market among the various styles and sectors.
Such extreme rotations remind us that there is risk in the equity markets even when stocks overall do not fall. Investors focused on relative performance likely either had a huge win or huge loss on Monday.
Growth leadership easing as rotation increases
One of the most notable market trends in recent weeks has been the corrective action in the formerly high-flying US large-cap Growth stocks. The dominant Tech-oriented companies that have been responsible for much of the gains in US large-cap indices for several months finally saw some significant selling pressure in the first two weeks of September.
The first chart below shows absolute and relative returns for the S&P 500 Pure Growth and Pure Value indices (i.e., the style indices restricted to stocks that fall entirely into their indicated style, leaving out those with weight in both indices).