August 2022 Venn by Two Sigma Factor Performance Report: Powell’s prediction? Pain.

In Rocky III, Clubber Lang (Mr. T) predicted pain. On August 26th, so too did Fed Chairman Jerome Powell when he said, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.¹”

Powell continued with hawkish comments as he communicated a renewed commitment to fighting inflation while simultaneously slowing economic growth.² Market participants, some of whom interpreted Powell’s comments one month earlier to be dovish, were surprised to say the least.³ 

Below we show performance across common risk factors in our Two Sigma Factor Lens for the month of August, some of which experienced high amounts of “pain” relative to their history.

Source: Venn by Two Sigma. The median and percentile columns measure the performance of each factor in the  Two Sigma Factor Lens relative to the entire history of the factor in USD, using monthly data for the period March 1995 - August 2022

Risk factors continue to respond to US central bank policy

Very similar to our July factor performance report, we saw big moves from the Equity and Interest Rates Factors after comments from Powell. More specifically, his dovish talk boosted markets to end July, while hawkishness acted as a negative catalyst to finish out August. Below we highlight some interesting factor performance before and after Powell’s speech.

Source: Venn by Two Sigma. Factor performance analyzed from 8/1/2022–8/25/2022 and 8/26/2022–8/31/2022, using the Two Sigma Factor Lens which comprises monthly data for the period March 1995 - August 2022

• Venn’s Equity Factor and Interest Rates Factor (long bonds) have fallen together YTD, but broke that trend through the first 25 days in August. However, after Powell’s comments, both equities and bonds again fell together when faced with talk of tighter than expected monetary policy. Equities moved down -4.41% in just four trading days, while our Interest Rates Factor had its single worst month since inception.⁴
  
  • Trend Following reversed course in August after falling during July’s market rally. Up over 4% for the month, it has continued to live up to its characterization as a market hedge, especially as equities and bonds struggle together.
    • Short positioning in the fixed income asset class was the primary driver of outperformance for the month.
• Foreign Exchange Carry is long high-yielding G10 currencies funded by low- yielding G10 currencies. Due to this factor's sensitivity to moves in Venn’s Equity Factor, we conduct residualization so the resulting return is a purer representation of the Foreign Exchange Carry Factor.⁵
  
  • A short position in JPY was beneficial as the Yen sold off in August, reaching its lowest level against the dollar since 1998.⁶
  • After Powell’s speech, the Foreign Exchange Carry Factor fell, suggesting outperformance of low-yielding currencies. This occurred despite Venn’s residualization, which would have acted as a tailwind to the factor since Equity Factor returns were negative.
• The Emerging Markets (EM) Factor posted a strong return both before and after Powell’s comments, after accounting for sensitivities to Equity, Interest Rates, Credit, and Commodities Factors, as well as a global currency basket.
  
  • The raw input to our EM factor (before residualization), which is a basket of equal weighted equity, fixed income and currency exposure, was down just -0.41% in August despite the market rout.
  • In equity specifically, the MSCI Emerging Markets index was up 0.42% in August, while developed international, measured by the MSCI EAFE index, was down -4.75%.
    • Exposure to both India and China helped EM Equity relative to developed countries in August. Both India and China, measured by their respective MSCI country index, were positive for the month. These two countries make up 14.5% and 32.1% of the MSCI Emerging Markets index, respectively.⁷

References to the Two Sigma Factor Lens and other Venn methodologies are qualified in their entirety by the applicable documentation on Venn.

REFERENCEs

¹ https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm

² https://www.reuters.com/markets/europe/gold-falls-dollar-holds-ground-with-focus-powells-speech-2022-08-26/

³ https://www.cnbc.com/2022/08/25/powell-isnt-likely-to-tell-investors-what-they-want-to-hear-friday.html

⁴ Common inception date for the Two Sigma Factor Lens is March 1, 1995

⁵Residualization for this factor takes into account exposure to the Equity Factor and its return. This leaves the return for the Foreign Exchange Carry Factor to be driven by what is above and beyond that attributable to the Equity Factor

⁶ https://www.reuters.com/markets/europe/ecb-goes-big-with-50-basis-point-hike-ending-negative-rates-era-2022-07-21/

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References to the Two Sigma Factor Lens and other Venn methodologies are qualified in their entirety by the applicable documentation on Venn.

This article is not an endorsement by Two Sigma Investor Solutions, LP or any of its affiliates (collectively, “Two Sigma”) of the topics discussed. The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma. This article (i) is only for informational and educational purposes, (ii) is not intended to provide, and should not be relied upon, for investment, accounting, legal or tax advice, and (iii) is not a recommendation as to any portfolio, allocation, strategy or investment. This article is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. This article is current as of the date of issuance (or any earlier date as referenced herein) and is subject to change without notice. The analytics or other services available on Venn change frequently and the content of this article should be expected to become outdated and less accurate over time. Any statements regarding planned or future development efforts for our existing or new products or services are not intended to be a promise or guarantee of future availability of products, services, or features.  Such statements merely reflect our current plans.  They are not intended to indicate when or how particular features will be offered or at what price.  These planned or future development efforts may change without notice. Two Sigma has no obligation to update the article nor does Two Sigma make any express or implied warranties or representations as to its completeness or accuracy. This material uses some trademarks owned by entities other than Two Sigma purely for identification and comment as fair nominative use. That use does not imply any association with or endorsement of the other company by Two Sigma, or vice versa. See the end of the document for other important disclaimers and disclosures. Click here for other important disclaimers and disclosures.