The European Central Bank (ECB) raised rates for the first time in more than a decade. As investors adjust to a complex new regime of tightening monetary policies, high inflation, slowing growth, and elevated geopolitical tensions, targeting high-quality companies at a reasonable price, combined with low volatility, may be beneficial.
This article was written with contributions from Federico Burroni. Federico is a Research Analyst on the SPDR Americas Research Team.
Markets trended upward last week, continuing their recent seesaw pattern. Just two defensive sectors, Health Care and Utilities, posted negative returns, -0.3% and -0.5%, respectively.1 And while the US 2-year yield fell below 3%, it still has a 10-year percentile rank of 99%.2
Earnings Season Continues
When Snap Inc., the company that owns Snapchat, reported worrisome earnings results, its stock price fell 39%.3 This week will see reports from other big tech companies, including Apple, Microsoft, Alphabet, Amazon, and Meta Platforms.
Interest Rates and Inflation Increase
In the US, the preliminary S&P Global US Composite PMI Output Index registered an unexpected 47.5 in July, an indication that business activity had contracted.4 And Q2 US GDP growth estimates just released this week were negative, as they were last quarter, meeting the technical definition for a recession. The Federal Reserve (Fed) is also expected to hike rates by at least 75 bps this month as it continues to combat inflation.
In the UK, surging inflation hit a 40-year high of 9.4% in June, driven mainly by energy costs and food prices.5
Tightening Monetary Policy in Europe
As anticipated, the ECB raised interest rates on July 21 for the first time in more than a decade to combat surging prices. But the ECB surprised markets with a hike that was double what had been expected, 50 basis points (bps) instead of 25 bps.6
Investors will need to adjust to the complex new regime of tightening monetary policies, high inflation, slowing growth, and elevated geopolitical tensions. A strategy targeting high-quality companies at a reasonable price, combined with low volatility, may be beneficial.
Developed ex-US equities are trading near historical lows relative to US equities,7 presenting an attractive value opportunity. But a balanced multi-factor approach to the region warrants consideration, given the elevated monetary policy uncertainty and ongoing geopolitical risks.
The SPDR® MSCI EAFE StrategicFactorsSM ETF (QEFA) provides broad exposure to the developed ex-US equity market while targeting quality, value, and low volatility factors. This may result in less downside than traditional market-cap weighted exposures during market turmoil, but higher upside capture than single-factor low-volatility exposures.8
Since inception, QEFA has ranked in the top decile among its active and passive peers based on maximum drawdown.9 It has also shown lower downside risk compared to the broader market, while maintaining upside potential — without the cyclicality of a single-factor low-volatility strategy.10
By blending defensive (quality) and cyclical (value) factors with a risk-based factor (low volatility), QEFA has outperformed the broader market with less volatility, lower drawdowns, and better risk-adjusted performance (see the chart).
Above-market Returns and Attractive Risk-adjusted Performance
QEFA Standard Performance as of June 30, 2022
1 Bloomberg Finance, L.P., as of July 22, 2022. 2 Bloomberg Finance, L.P., as of July 22, 2022. 3 Bloomberg Finance, L.P., as of July 22, 2022. 4 www.pmi.spglobal.com 5 www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2022 6 https://www.ecb.europa.eu/press/pr/date/2022/html/ecb.mp220721~53e5bdd317.en.html 7 FactSet, as of July 21, 2022, based on next-twelve-month P/E. 8 FactSet, as of June 30, 2022. Since June 30, 2014, the first full calendar month after QEFA’s inception. 9 Morningstar, July 1, 2014 – June 30, 2022. The percentile was prepared by State Street Global Advisors and based on the Morningstar US Fund Foreign Large Blend category (including both actively and passively managed funds, oldest share class of multi-class funds). Rankings are based on maximum drawdown of the funds in the category following the first full calendar month after QEFA’s inception. Total universe was 160 funds. Median maximum drawdown for the universe is -35.35. QEFA’s maximum drawdown is -30.71.
10 Morningstar, as of June 30, 2022. Low volatility factor strategy is represented by MSCI EAFE Minimum Volatility Index. Upside and downside capture are measured versus the MSCI EAFE Index for the period July 1, 2014 – June 30, 2022. Past performance is not a reliable indicator of future performance.
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