Global Factor Views: Macroeconomics favour Quality and Low Volatility stocks

In Europe and the US, inflation is not far from the central banks’ targets but there are signs that economic growth is slowing. US payroll data was weaker than expected in July, raising concerns that macroeconomic conditions may slow more than anticipated, unsettling equity markets.

A backdrop of slowing inflation and softer macro data means that markets expect interest rates to fall as central back attention switches to managing growth and labour market risks.

In addition, the Institute for Supply Management (ISM) New Orders Index declined in July which resulted in the macro indicator on our factor dashboard switching to a ‘deceleration’ phase.¹

In August, after measuring the macro, interest rates, valuation and technical indicators, the highest ranked factors were found to be Quality and Low Volatility while Value and Momentum were the lowest ranked.

Low Volatility is the most improved factor compared to last quarter - it typically performs well in slowing macro conditions while valuation and technical remain supportive. Momentum has fallen to the bottom of scorecard, though its aggregate score is neutral. Presently few factor scores are at extremes and, for now, there is little difference between the total score for Growth, Value and Momentum.

We set out in detail our outlook for equity market factors below.

Quality: Positive

Our factor dashboard continues to have a positive ranking for Quality. Quality stocks – those with premium levels of profitability - tend to be rewarded when macro sentiment is in a ‘deceleration’ phase of the cycle. Overall, the valuation of Quality is trading at a premium to the average level; however, unlike other factors, Quality’s performance has not historically been sensitive to periods of high valuation. We would recommend an active approach to Quality investing with a focus on forecast Quality which is more adaptive to changing economic conditions.

Low Volatility: Positive

Low Volatility is now positively ranked on our factor dashboard and is the most improved factor compared to last quarter. The improvement has been driven by our macro indicator pillar moving into a deceleration phase of the cycle, which typically favours the Low Volatility factor. While falling interest rates often weigh on the performance of Low Volatility, this is normally due to the cycle moving into a recovery phase, rather than current conditions where rates are falling to manage a growth slowdown. Because Low Volatility has been out of favour recently, its valuation and technical indicators are also supportive.

Growth: Neutral

Growth is neutral-ranked on our factor dashboard. Our macro indicator, which is based on the level and rate of change of the ISM New Orders Index, is now in a deceleration phase of the cycle which, historically, does not tend to favour the Growth factor. This headwind is however tempered by prospects of falling interest rates – something that is typically supportive of Growth. Strong first-half performance for Growth has resulted in the factor becoming ‘crowded’- i.e. very popular - which results in a negative score on technical indicators.  

Value: Neutral

Value - stocks which appear to be trading for less than their underlying worth - is also neutral-ranked on our factor dashboard. Slowing macro momentum has not historically been supportive for Value, given the factor exposure to more cyclical parts of the market. Falling interest rates also weigh on the outlook for Value as investors typically favour longer duration growth stocks as rates fall. Value’s valuations, however, are reasonably attractive on some measures, alongside technical factors which are also supportive. 

Momentum: Neutral

Price momentum as a factor captures stocks that have a positive price change, relative to the market, over the last 12 months. And Momentum was the highest ranked factor for much of 2023 and the first quarter (Q1) of 2024. Its ranking fell in April after its technical score deteriorated. Specifically, momentum stocks at the end of Q1 were starting to exhibit low levels of performance dispersion, which is an indicator of factor crowding and, historically, a warning signal for the factor.

While the crowding issue has not deteriorated has since April, it remains elevated, and this continues weigh on the factor’s overall score. Furthermore, slowing macro momentum is also typically negative for Momentum and, as such, it has now moved to be the lowest-ranked factor on our dashboard.