Axioma Risk Monitor
AXIOMA RISK MONITOR
Equity edition

Developed Europe crumbles as virus hits
Italy becomes the riskiest developed country
Developed market asset correlations at 20-year high
Increased dispersion accompanies market turmoil

 

HIGHLIGHTS FOR THE WEEK ENDED MARCH 12

 
 
 

Developed Europe crumbles as virus hits

 

Nearly every major market tanked last week, despite the efforts of central banks and governments to mitigate the impact of the coronavirus. Many major indices officially breached bear-market thresholds and volatility continued to spike, as the coronavirus outbreak was declared a pandemic by the WHO, as oil prices plummeted, and as concerns grew about the future of the global economy, following steep drops in business activity, disrupted supply chains, and curtailed global trade and travel.

Developed Europe was among the hardest hit of the regions Axioma tracks closely, following the surge in coronavirus cases in Europe—and the Trump administration’s ban on European travel to the US didn’t help matters. FTSE Developed Europe recorded a weekly loss of 23%, with its risk more than doubling, as measured by Axioma’s Developed Europe short-horizon fundamental model. Developed Europe, with volatility of 38.6%, became the riskiest among all regions Axioma models track closely. In comparison, the Russell 1000 ended the week with a volatility level of 31.7% and FTSE Developed Markets was at 33.0%.

The decomposition of the change in risk from the point of view of the factor model showed that the rise in factor volatility was solely responsible for the jump in Developed Europe risk, while the change in factor correlation offset a small part of the increase. When analyzing the decomposition of risk from the stock-level vantage point, the increases in both stock volatility and stock correlations drove up equity market risk, but the rise in stock volatility had a bigger impact. We saw this pattern across most regions Axioma models cover.

See graph from the Developed Europe Equity Risk Monitors as of 12 March 2020:



 

Italy becomes the riskiest developed country

 

Most countries suffered their biggest selloffs since the financial crisis, with six-month returns (denominated in US dollars) well below -20% for most developed countries. Turkey was the only country, among both developed and emerging markets, to see a positive six-month return as of last Thursday. European countries were particularly hard hit, with Austria, Italy, Poland and Greece all posting losses of greater than 30%.

Most countries saw double-digit percentage point increases in risk last week, as measured by Axioma’s Worldwide short-horizon fundamental model. Risk for Poland, Italy, Brazil and Spain rose more than 25 percentage points over the past five days. Italy became the riskiest developed country, as its government placed the entire nation under quarantine. But Poland and Greece (two emerging countries) were even riskier. Greece’s volatility now surpasses 50%.

Interestingly, China’s six-month loss is now the smallest among both emerging and developed countries, while its volatility also stayed lower than that of many nations.

See graph from the Equity Risk Monitors as of 12 March 2020:

 

 

Developed market asset correlations at 20-year high

 

Asset-asset correlations shot up around the globe, rising at least 2% in all countries last week, as shown in the global volatility hotspots chart. At an aggregate level, both 20-day and 60-day median realized correlations for stocks in the FTSE Developed index tripled in March, rising to levels not seen in at least 20 years. While correlations for assets in FTSE Emerging also went up, they did not rise to the levels of those in their developed counterparts. The US saw the highest level of correlations, with the median pairwise realized 20-day asset correlation in the Russell 1000 climbing above 0.70 points.

A similar pattern was observed in most other markets Axioma covers closely. The increase in correlations has several implications: it has been a major contributor to the overall increase in risk; it suggests that benchmark and portfolio risk is currently less stock-specific and more factor-driven (notably the Market factor); and it means that the Diversification Ratio is continuing to fall—all of which present further challenges for active managers For more guidance on the implications of high correlations, see our paper Successfully Riding the Correlation Rollercoaster.

See graphs from the Developed Markets Equity Risk Monitor as of 12 March 2020:


 

 

Increased dispersion accompanies market turmoil

 

Asset dispersion widened over the past four weeks as markets tanked. The selloff has been indiscriminate, with most regions seeing no winners last week. Dispersion, the cross-sectional standard deviation of weekly returns, widened in all regions Axioma tracks closely, except for China. For investors seeing the market rout as a buying opportunity, higher dispersion would benefit high conviction stock-picking portfolios.

See graph from the US Equity Risk Monitor as of 12 March 2020


 

 

 
 
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Webinar | Qontigo Insight™ Q1 2020 Risk Review

Date: April 7, 2020
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With volatility skyrocketing in the first quarter, it is more important than ever for managers to understand the risk environment, and in particular know how to mitigate unwanted risks. In this webinar we will review first-quarter risk results starting from the benchmark level, and then drill down into specifics from country, sector, style and other components of risk.

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Qontigo ROOF Scores

Qontigo's ROOF Scores were created to quantify market sentiment — bullish or bearish? ROOF is an acronym for Risk-On/Risk-Off market conditions; the Scores are calculated from the factor returns to eight style factors from Axioma’s fundamental factor risk models, plus two indicators of changing market volatility. 



On the Blog

Time to put the stress (test) on the coronavirus for a change…

As the immediate effects of the rate cuts wear off, investors are beginning to brace themselves for yet more market turbulence. No one knows, of course, how much more share prices are likely to fall. However, stress testing is a good way of estimating the impact of another stock-market downturn on other asset classes.

Sectors Have Feelings Too: Developing a Sector-Based Sentiment Indicator

Last year we introduced the Qontigo ROOF Scores as a market sentiment indicator. Recently it occurred to us that a similar indicator could be derived using sectors. We could characterize each sector based on its exposure to the style factors in the original methodology and map each sector to a risk-tolerant or risk-averse strategy. 

Markets — and Factor Returns — Run Wild: Time to Check Your Bets

As of March 5, the STOXX USA 900 was down almost 11% from its recent peak on February 19. Returns in other markets have been equally dismal. Indeed, the magnitudes of recent market swings have been substantial, and probably seemed even worse given the relatively low levels of volatility prior to February.

The Market Rout by the Numbers

Market concerns finally came home to roost in recent days. The STOXX USA 900 index fell about 6.5% from February 24 through 25, with other markets around the world seeing similar declines.

Cometh the Bad News, Befalleth the Selling

The US market has been broadly aligned with investor sentiment since early October, with both rising in tandem as investors celebrated the news of a phase one trade deal between the US and China, ending a two-year trade war that had rattled markets. Then, news of the coronavirus outbreak in China hit the front pages.

 

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