May Venn Factor Performance Report
For the 6th month in a row the YoY CPI printed 7% or higher, and for a 3rd consecutive month over 8%. These are levels of inflation not seen since the 1980s, which left the Fed in full focus as they attempt to counteract it.1
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 - May 2022.
In their early May meeting, the Fed performed its largest single rate hike since 2000 at 50bps, which was in line with expectations. They also announced that they will be shrinking their bond portfolio starting June 1st, activating another tool to potentially push rates higher and curb inflation by reducing money supply and credit availability. 2
In April, Venn’s global Equity Factor was down -6.49%, and fell another -5.08% through May 19th. Despite this, the equity factor rallied and managed to finish the month down just -0.29%, emphasizing the high volatility in current market conditions.
In fact, as investors attempted to digest the plethora of uncertainties including inflation, Fed policy and the war in Ukraine, the VIX reached as high as 36.64 intraday in May, 87% higher than its 20-year average closing price.3 As a result of this heightened volatility, Venn saw historically significant underperformance in the Equity Short Volatility Factor, which fell -2.44%.4
Upcoming monetary policy decisions will likely be consequential for equity markets as the Fed discussed a two-phase approach5: First getting rates back to neutral—a level that neither activates nor hampers the economy, and then pausing to assess the impact. Some market participants have speculated this may leave room for a more dovish shift which could provide equity tailwinds.5
Value: Too soon to call it a comeback?
- The Value Factor’s outperformance in periods of high inflation, which tends to coincide with higher discount rates, is well documented6. Higher inflation means that a dollar today is worth more than that same dollar tomorrow. As a result, the short side of the Value Factor, often thought of as growth, tends to be affected negatively as its expected cash flows are further into the future. The opposite is true for the long side, where cash flows are expected in the more immediate future.
- From December 2016 through October 2021, Venn’s Value Factor posted a significant drawdown relative to its history7, returning just shy of -40%.
- Since November 2021, Value is up almost 31% and has been positive for 7 consecutive months, 4 of which posted returns in the top 10th percentile compared to its historical average. Excluding April, YoY CPI has risen every month from the start of this rally, beginning at 6.8%.
Value Factor cumulative performance
Source: Venn by Two Sigma. The chart displays the 5-year cumulative return of the Value Factor in the Two Sigma Factor Lens in USD, using daily data for the period ending 5/31/2022.
Local Inflation: Not what you expected
- Despite another significant rise in US inflation, Venn’s Local Inflation Factor achieved a meaningful negative return relative to its history, as inflation-linked bonds in the US underperformed nominal treasuries.
- This factor captures returns to a local-currency inflation hedge that will benefit when inflation surprises to the upside, but otherwise will tend to lose money due to being short the inflation risk premium8.
- From February to April, this factor was positive indicating that inflation had been edging upwards, and that inflation hedges had been successful9.
- Negative performance in the month of May marks a notable shift in the trend of positive performance, which might be expected should inflation be peaking.
Local Inflation Factor cumulative performance
Source: Venn by Two Sigma. The chart displays the 5-year cumulative return of the Local Inflation Factor in the Two Sigma Factor Lens in USD, using daily data for the period ending 5/31/2022.
References to the Two Sigma Factor Lens and other Venn methodologies are qualified in their entirety by the applicable documentation on Venn.
REFERENCEs
1https://tradingeconomics.com/united-states/inflation-cpi
3https://www.cboe.com/tradable_products/vix/vix_historical_data/
4Venn’s Equity Short Volatility Factor is residualized against Venn’s Equity factor, suggesting that volatility spiked higher than what the move in equities might suggest
6https://www.mfs.com/en-us/institutions-and-consultants/insights/equity/equity-styles-and-factors-during-periods-of-high-inflation.html , visited 5/31/2022
7Inception for Venn’s Value Factors is March 1,1995
8The inflation risk premium is the compensation that nominal bond investors might require for their exposure to risk of inflation fluctuations.
9Our local inflation factor is residualized against Interest Rates, Equity, Commodities and Credit, meaning it removes the effects of possible inflation hedges that exist within Equity, Commodities and Credit, for example. A positive return indicates that the inflation hedge you have above and beyond other assets was successful.
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