Venn by Two Sigma June and H1 2023 Factor Performance Report: Inverted Yield Curves, Bank Failures and Roaring Equity Markets

After reaching the end of the first six months of 2023, this monthly report will shift its focus towards H1 factor performance. With that in mind, Exhibit 1 does show the factor performance for June only. Perhaps most notable is the Equity factor roaring ahead at greater than 5% return. Additionally, the Crowding factor was meaningfully negative, suggesting that short equity positions in heavily shorted stocks underperformed long positions in stocks not heavily shorted.

Exhibit 1: June 2023 Two Sigma Factor Lens Performance

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 - June 2023

H1 2023 Update

The first half of 2023 saw the deepening inversion of yield curves, decelerating global inflation, banks failing, and strong equity markets. 

Given some of these themes, let’s look at performance of the Two Sigma Factor Lens in the first six months of 2023.

Exhibit 2: H1 2023 Two Sigma Factor Lens Performance

Source: Venn by Two Sigma

Notable Positive Performance

• Thus far in 2023, Equity and Interest Rates factors are up 11.72% and 1.01% respectively. Despite both factors being positive over this short period, they have exhibited a negative correlation of -0.15, which aligns with their long-term relationship. In contrast with 2022, our Equity and Interest Rates factors exhibited a 0.38 correlation, down -17.19% and -12.51%, respectively. 
• In 2022, market dips were often associated with higher than expected inflation and rate hikes, hurting equities and bonds alike. YTD, the only significant market shock has been bank failures in March, during which bonds lived up to their role as a safe haven and diversifier to equities (Exhibit 3). 

Exhibit 3: YTD Cumulative Return of Equity and Interest Rates Factors

Source: Venn by Two Sigma

• Quality has returned 4.88% YTD, likely benefitting from themes such as the reemergence of the tech sector (tech being a typically net long quality exposure) and bank failures (banks being a typically net short quality exposure). In exhibit 4, we can see Value has been reacting in the opposite direction to the same themes, most evidently during bank failures in March (more Value commentary later). Quality and Value have exhibited a -0.47 correlation in 2023, but only a -0.04 correlation back to 1995.

Exhibit 4: YTD Cumulative Return of Quality and Value Factors

Source: Venn by Two Sigma

Also of note is Quality’s negative correlation to the Small Cap factor, both YTD (-0.75) and historically back to 1995 (-0.30). It is common for Quality companies to be associated with larger market caps, potentially providing resiliency in slow growth environments like that of 2023. The opposite can be said for the Small Cap factor, which may be more susceptible to economic slowdowns or downturns. 

• While Fixed Income Carry has not had standout performance, abnormal yield curves affect this factor’s positioning considerably and are worth discussing.¹ Relatedly, rising short-term rates affect Foreign Exchange Carry positioning. A good example of this dynamic can be found in the U.S. and Canada, where yield curves have become increasingly inverted as short-term rates have risen faster than long-term rates. 
  
  • The FI Carry factor began 2022 with long positioning in U.S. and Canadian 10-year bonds, but both governments began hiking interest rates during the summer, contributing to negative term spreads, or the difference between 10-year and 3-month yields (Exhibit 5). After comparing these term spreads across other developed countries, FI Carry has been short U.S. and Canadian 10-year bonds from June 2022 onwards. 
  • In contrast, as short-term rates have risen for the U.S. and Canada, those currencies have become more attractive for FX Carry, which has been long both in 2023. 
  • Notably, FI Carry and FX Carry are residualized against our Interest Rates and Equity factors, respectively. 

Exhibit 5: Short and Long-Term Bond Yields for the U.S. and Canada, 2022–2023

Source: Bloomberg

Notable Negative Performance

• Value had a difficult start to the year, down -6.87%. Of the different signals used for our Value factor, when viewed as separate portfolios, dividend yield has been the worst performing, down -6.46%. This may be intuitive in an environment where rates are rising and dividend yield is sometimes considered a bond proxy within equity markets. Additionally, with cash rates so high, investors may be reallocating portions of income-seeking portfolios from equities to fixed income. 
  
  • Additionally, various themes throughout the year have moved against Value, including turmoil among regional banks and a tech-themed comeback headlined by AI. 
  • Finally , it is worth noting that performance for Value has reversed since 2022 when it was the best performing factor in our lens, up 25.57%

Exhibit 6: YTD Cumulative Return of Separate Value Portfolios 

Source: Venn by Two Sigma

• Our Commodity factor has fallen -5.29% YTD after residualization against our Equity factor (among other factors). Like Value, this factor was among the best performing in our lens in 2022. Insights into falling commodity prices can be found in the World Bank’s April Commodity Markets Outlook, which notes: “the price surges [of commodities] that followed the Russian Federation’s invasion of Ukraine have largely been unwound due to a combination of slowing global economic activity, favorable winter weather, and the redirection of trade of key commodity exports from Russia and Ukraine.”²
  

• Perhaps the most intuitively related factor to regional bank failures is Credit, which has been among the worst performing factors for the year. Credit has faced headwinds since March 2023 when regional banks in the U.S. began to fail and global credit markets tightened. Various other headwinds followed, including the failure of First Republic Bank in May and the increased default risk surrounding U.S. debt ceiling discussions. Notably, our Credit factor is residualized against our Equity and Interest Rates factors. The raw Credit input was up 4.28% YTD.  

Exhibit 7: YTD Cumulative Performance of the Credit Factor

Source: Venn by Two Sigma

REFERENCEs

¹More on this and rising cash rates can be found in our February performance report.

²  https://www.worldbank.org/en/research/commodity-markets

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

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