In recent weeks, market perception of a strong recovery has led to a corresponding sell-off in bond markets. This has led a fresh theme to take shape in equity markets: Interest rate sensitivity has become a more important explanation of returns than risk, or value, or COVID-19 winners versus losers. When these types of top-down, macroeconomic influences on stock returns start to overshadow the influence of bottom-up stock selection, it’s important to understand a portfolio’s exposure to these top-down trends. In Active Quantitative Equity (AQE), our portfolios are not exposed to extreme interest rate sensitivity.
When selecting stocks, we focus on three important themes – value, quality, and sentiment. We look for companies that are reasonably priced, profitable, solvent, efficient, with improving outlooks. We don’t explicitly prefer stocks that are positively or negatively impacted by moves in interest rates; however, the characteristics we do affirmatively seek can have a relationship with interest rate sensitivity.
Interest rate sensitivity has been the major driver of equity market returns since rates started moving in mid-February. Figure 1 shows that returns are currently highest for the interest rate sensitivity factor compared to other explanatory factors such as value, beta, and return on equity. Valuation multiples, especially book-to-price ratio, are positively correlated to interest rate sensitivity and also have been performing strongly.
Deep value strategies with a lot of exposure to cheap price-to-book stocks have undoubtedly performed well during this period. We prefer to take a more balanced approach to selecting stocks. By introducing sentiment and quality themes, we reduce the sensitivity to interest rate moves.
This phenomenon has also manifested itself among sectors, as seen in Figure 2. Here, we show the sensitivity of various industry groups to interest rates versus the returns to each group since February 12, overlaid with our most- and least-preferred segments based on our assessment of expected returns. Cheap segments like Banks and Energy currently have a positive exposure to interest rate increases, while high-growth and expensive segments, like Household Products, Software, and Pharmaceuticals have a negative exposure. Because of our balanced approach to selecting stocks, our preferences in AQE do not overly favor or avoid stocks with positive or negative interest rate sensitivity.
Our stock selection model’s preferences are not particularly exposed to extreme interest rate winners and losers. This stems from our use of a diversified set of inputs to evaluate stocks. Our most preferred segments include pharma (which has a negative exposure to rising rates) as well as banks (which are positively exposed to rate increases). Our least preferred segments include household products (negative sensitivity) as well as consumer services (positive sensitivity).
We prefer to keep our portfolio exposure to interest rate sensitivity in check rather than bet on macroeconomic influences that are less predictable than the bottom-up stock characteristics. Not only are the macroeconomic events difficult to predict themselves, but the way the stock market reacts to these events can change.
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The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The views expressed are the views of Active Quantitative Equity through March 12, 2021, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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