2023 Year in Review International Markets
In 2023, international markets saw higher levels of alpha than US.
- 29% of the weeks in 2023 were at least “Factor-Driven” (Compared to 39% in the US). This was less than half the level seen in 2022.
- 47% of the weeks were at least “Alpha-Driven,” which was almost four times the level seen in 2022 and far higher than the US (33% of the weeks were at least “Alpha-Driven”).
Unlike the US, International Markets were far calmer. Only 22% of the weeks were "Volatile" (compared to 45% in the US). In aggregate, this marks the lowest percentage of volatile weeks observed in the International portfolio since 2019.
Similar to the US, the Size factor had a return of 7.81% in Developed Markets, its highest ever annual gain for this factor in our recorded history.
Other notable highlights from our analysis:
- International investors were cautious: Residual Volatility, often used to measure risk aversion, had a 6th percentile allocation since inception in “up” markets, sign that 2023 was a historically cautious year.
- Macro factors were more important in international markets than in US: and Wolfe’s Oil Beta and Interest Rate Beta factors demonstrated investor behavior around the dynamic landscape. Both factors fell into the 6th percentile of average exposure since inception while Interest Rate Beta reached its highest ever level of exposure which means that, during periods when the broader market struggled, investors looked to stocks that tended to favor higher rates and did so to a greater degree than ever before. In addition, the Oil Prices factor which had a performance of -2.80%, its second lowest since 2008.
- China, on average, saw a short allocation of almost 9%. That negative allocation was the lowest historically amid a decline in exports and geopolitical turmoil surrounding Taiwan.
Factor Influence and Market Volatility Review
2007 - Present: Classifying “Factor-Driven” and “Alpha-Driven” Markets
This analysis will focus on the global market using our International Extreme Movers Portfolio. The portfolio is a weekly-rebalanced, market-neutral portfolio that invests long in the top decile of best performers and shorts the bottom decile of performers in the MSCI ACWI ex-US index. The characteristics and performance of the Extreme Movers Portfolio point to the areas of the market that were in and out of favor and provide valuable insight into themes that drove stock returns.
Our International Extreme Movers portfolio began on April 1, 2008. Each week, we observe performance decomposition through the lens of various risk models and use quintiles to categorize the performance on a spectrum of the most “Alpha-Driven” weeks to the most “Factor-Driven” weeks. To calibrate our classification, we took the total sample of all weeks (>820) since April 1, 2008, and ranked them by Alpha Contribution to return percentage.
A Very Alpha-Driven Week (Top Quintile) is one where an Alpha Contribution to return is HIGH and a Very Factor-Driven Week (Bottom Quintile) is one where Alpha Contribution to return is LOW.
Below are the Alpha Contribution thresholds that define the quintiles:
In addition to understanding what portion of the market volatility was attributable to factors and alpha, we also need to proxy the market volatility levels. We applied the same ranking methodology to categorize the volatility of weekly periods based on the total return of the International Extreme Movers portfolio. We categorized these quintiles from “Very Volatile” to “Very Calm.”
To break down the historical context, we segmented the historical data by calendar year and market regime to give investors a sense of how the recent and current market stack up against prior periods. Details on the thematic market regimes are below.
Aggregating Weeks into “Alpha-Driven” vs. “Factor-Driven” Periods
The availability of alpha in the markets is critical for fundamental investors. Historically, there have been periods during which the majority of volatility in the market was attributable to stock-specific nuances. These periods provide ample opportunity for stock-pickers’ competitive advantage to shine. There have also been periods that were clouded by market factors, restricting the fundamental investor’s ability to drive idiosyncratic returns.
Here, we’ve broken down the weeks in each year since 2008 according to our spectrum of “Very Factor-Driven” to “Very Alpha-Driven” and examined the percentage of weeks in each category. In doing so, we found that only 29% of the weeks in 2023 were at least “Factor-Driven.” This was less than half the level seen in 2022, and aligned closely with what was seen in 2021 as well as several Post GFC + Pre-COVID years (namely 2012 to 2014, and 2017 to 2018).On the other hand, 47% of the weeks were at least “Alpha-Driven,” which was almost four times the level seen in 2022. This distribution suggests that bottoms-up, fundamental stock-pickers in international markets were even better positioned than their US counterparts over this past year to uncover opportunistic stocks that were not over-influenced by market and macroeconomic forces.
When comparing to market regimes, we can see that 2023 presented more alpha opportunity than any of these periods. The Post-GFC + Pre-COVID regime was the most similar, with 43% of at least “Alpha-Driven” weeks overall. However, the “Very-Alpha Driven” weeks in 2023 exceeded this regime by 9%. The level of at-least “Factor-Driven” weeks in 2023 was also lower than any other period, with the Post-GFC + Pre-COVID regime having 8% more weeks in the factor-driven categories. Interestingly, the proportion of “Neutral” weeks in 2023 most closely aligned with both the COVID and Global Financial Crisis periods.
Aggregating Weeks Into Volatile vs. Calm Periods
In addition to the breakdown of Extreme Mover's performance into factor and alpha, a key area we looked at was the level of volatility in the portfolio. The charts below aggregate each week since 2008 on a scale of from "Very Calm" to "Very Volatile," across calendar years and market regimes. We found that the International Extreme Mover's portfolio saw significantly less volatility in 2023 than the US portfolio did, with only 8% of weeks being classified as "Very Volatile" and 22% as "Volatile". In aggregate, this marks the lowest percentage of volatile weeks observed in the International portfolio since 2019. We also saw 35% of at least "Calm" weeks, which measures over five-times higher than 2022. The percent of neutral weeks in 2023 exceeded all other years since 2008.
Relative to recent market regimes, the percent of at least “Volatile” periods in 2023 was again similar to the Post-GFC + Pre-COVID period, which saw the lowest percentage of volatile periods. The percent of at least “Calm” periods in 2023 was exceeded only by the FactorMaggedon + Election and Post-GFC + Pre-COVID regimes, while the percent of “Neutral” weeks was the highest observed. The distribution of volatility levels in 2023 suggest that international markets were markedly less volatile than 2022 and the COVID years, in stark contrast to US markets, which have remained historically volatile.
Elevated Volatility with Factor Influence
To deepen our analysis of the International Extreme Movers portfolio, we next examined the cross-section between considerably factor-driven and considerably volatile periods to understand how often the international market was heavily volatile because of factors. The intersection of these categories represent periods where alpha is far less available, but stock prices are experiencing significant price movements, creating a challenging environment for fundamental investors.
The chart below presents the percentage of weeks each year categorized as at least "Factor-Driven" and at least "Volatile." This lens more clearly highlights that international markets in 2023 experienced barely one quarter of the factor-driven volatility that was present in 2022. Instead, there were only 6% of weeks in 2023 that were “Very Factor-Driven” and “Very Volatile”, and 8% of weeks that were “Factor-Driven” and “Volatile.” Of the periods in our analysis, 2023 was most similar to 2018.
The percent of factor-driven volatile weeks in 2023 was also lower than any of the recent market regimes we examined. The Post-GFC + Pre-COVID period was most similar, but had 5% more “Volatile & Factor-Driven” weeks than 2023.
Extreme Movers Exposure Analysis
Though the International markets generally favored similar sectors as the US, the magnitudes of allocation were much more muted during 2023 in ex-US markets. Financials and Information Technology were the largest long allocations on average throughout the course of the year at just 1.5% whereas we saw last week that Information Technology had a 4.9% average allocation in the US. This points to the fact that international investors likely felt less price pressure from broader sector flows than US investors.
While the industries in Information Technology were distributed, Banks were the largest industry-level long allocation in the International portfolio, with an average allocation of 1.5%. Financials were also much more heavily favored during “down” market weeks relative to “up” weeks. The Materials sector showed the greatest disparity in allocation depending on the direction of the overall market. When the market was up the average allocation to Materials was 1.3% relative to a -4.6% average when the market was down. This divergence was most pronounced in Metals & Mining where stocks rallied during bull markets and sold off significantly during bear markets.
Style factor exposures in the International portfolio pointed to strong levels of risk aversion among investors and a preference for “safety”. Characteristically, this differs from what we observed in last week’s US summary which showed a willingness from investors to take risk, particularly as it pertained to Beta factors.
While Beta factors were in favor in ex-US markets during “up” weeks, the aversion to beta in “down” weeks rendered the factor neutral for the year. Residual Volatility factors, on the other hand, were consistently negative. Residual Volatility is often used to measure risk aversion, so a -0.14 average exposure in Barra’s Global Equity model, which fell in just the 6th percentile since inception in “up” markets, was a clear sign that 2023 was a historically cautious year. Value factors (particularly Earnings Yield) were heavily favored in “down” markets. Axioma’s Earnings Yield factor reached its 94th percentile of average yearly exposure since inception.
Macro was a major theme of 2023 and Wolfe’s Oil Beta and Interest Rate Beta factors demonstrated investor behavior around the dynamic landscape. Both factors fell into the 6th percentile of average exposure since inception while Interest Rate Beta reached its highest ever level of exposure which means that, during periods when the broader market struggled, investors looked to stocks that tended to favor higher rates and did so to a greater degree than ever before.
We also observed the highest level of positive HF Crowding exposure during down market weeks since inception which suggests that hedge fund managers collectively leaned into consensus favorites when markets declined.
2023 demonstrated the largest bias toward Developed Markets relative to Emerging Markets since 2015. In 2022, the average weekly allocation to Developed Markets in the International Extreme Movers portfolio was -4.8%. In 2023, that allocation jumped to 3.1%.
DM Americas and Europe were the key winners from a Developed Markets perspective. The UK and Denmark were leading allocations in the portfolio and also both landed in their respective top quintiles since inception while Japan carried the torch for Developed Markets Asia Pacific with an average allocation of 1.15%.
Emerging Markets were far more dispersed. EM Americas had a very strong year, particularly in Brazil and Mexico where both countries landed in the top decile since inception. In Europe, Poland and Greece saw their highest annual average allocations on record. In Asia, however, China, on average, saw a short allocation of almost 9%. That negative allocation was the lowest its seen since the portfolio’s inception amid a decline in exports and geopolitical turmoil surrounding Taiwan.
Style Factor Return Spotlights
In 2023, several style factors diverged from their long term trends. The market exhibited a strong preference for large cap names especially in developed markets. Names with positive correlation to oil prices took a hit as Crude prices fell dramatically in the fourth quarter.
Historically, small cap stocks have consistently outperformed large cap stocks. Axioma Worldwide’s Size factor had averaged -1.41% from 2007 to 2022. However, a notable deviation from this trend occurred in 2023 when larger-cap companies experienced a significant turnaround, resulting in a Size return of 6.53%. This positive performance was particularly pronounced in Developed Markets where the factor had a return of 7.81%, its highest since the beginning of 2007. Conversely, the Size factor in Emerging Markets fell by -5.92%, indicating a continued preference for smaller-cap companies in that segment of the market.
In the past year, Oil Prices emerged as an underperforming factor, diverging from its positive long-term trend, which had averaged 0.31% annually since 2007. In 2023, the market showed preference to companies with low exposure to oil, resulting in a downturn in the Oil Prices factor which had a performance of -2.80%, its second lowest since 2008. This factor saw its biggest fall in performance in late October 2023 as Crude Oil slipped and continued to fall through the rest of the year. Geopolitical conflicts in the Middle East significantly impacted oil markets by raising concerns over the general stability of global oil production and distribution. This contributed to a negative shift in investor sentiment affecting companies with high sensitivity to oil prices.
Kevin, Reshma, Jose, and David
The Omega Point Product Specialist Team