Despite the media expectations of a swift market crash following the U.S. presidential elections on November 8, 2016, the markets actually continued going up significantly (Figure 1 and Figure 2), continuing the rally that has been active since November 4, 2016.
Figure 1 Russell 2000 Levels since 09/01/2016
Figure 2 S&P 500 Levels since 09/01/2016
There was a major shift, however, in the structure of the gains, in that they were coming mostly from small cap stocks. This can be seen via a factor that we have constructed from the MSCI Small Cap Value, MSCI Small Cap Growth, MSCI Large Cap Value and MSCI Large Cap Growth indices shown in Figure 3.
Figure 3 Small Minus Large Values in the Period 9/1/2016 - 11/16/2016
We decided to delve deeper into the story, using the BISAM Cognity U.S. Fundamental Factor Model (FFM) to evaluate the magnitude of the shift, and whether or not the small vs large tilt is, indeed, all there is to it.
Analysis using the Styles from Cognity U.S. Fundamental Factor Model
First, a straightforward comparison can be drawn between the index from Figure 3 (above) and the size factor from the Cognity U.S. Fundamental Factor Model on Figure 4 (below).
Figure 4 Size Factor Values in the Period 9/1/2016 - 11/16/2016
Both factors have very similar behavior on the surface, but the SML index usually has a bit of market beta still present in it, while the U.S. FFM factor is designed to be completely market neutral. This affects the significance of the observed events and can be seen via the following simple comparisons for the period starting October 1, 2016:
Table 1 Comparing the US FFM Size Factor and the MSCI Small minus Large Index
Thus, we can more clearly see the extent of the small-caps bias via the Cognity US Fundamental Factor Model.
What about the other styles?
Exploring the other Styles from the Cognity U.S. Fundamental Factor Model we can see that there has been another significant rally in recent times, that of the value factor:
Figure 5 Value Factor Values in the Period 9/1/2016 - 11/16/2016
Post-election the value factor steadily continues its surge that has begun at the end of September, while the rest show no unusual moves in the last week. As value companies represent blue-chips, this has been a characteristic flight to quality for the last two months, so investor expectations of a looming crisis have evidently not yet been averted. This leans heavily towards the explanation of the small-caps rally that it is due to expectations of lowering regulations, rather than general expectations of future well-being.
What is the impact of that style to the recent returns, however? To analyze this, the Russell family of indexes is considered in the following summary.
Figure 6 Style Betas for the Major Russell Indices
First, aggregating over the indexes, we can see the betas towards the different factors. As expected, a big differentiator is the size factor (as this is how indexes are selected), but also value, liquidity, growth and other factors have significant tilts for the different indexes.
To ascertain to what degree this translates to impact over the return, Figure 7 contains the component contribution to the realized returns of the indexes for the period 11/09 - 11/15 while Figure 8 presents them in percentage terms.
Figure 7 Component Contribution to 5-day Return for the major Russell Indices
Figure 8 Percentage Contribution to 5-day Return for the major Russell Indices
In the figures above, we can see that the contribution of the value factor is very small, compared to the market for the five days, and even less compared to the size factor. The other factors have had an even smaller impact over the period.
Additionally, we can see that the small cap indices Russell 2000 and Russell 2500 produce far greater returns than their large cap counterpart – Russell 1000. The fact that the U.S. market is generally going up since Election Day is reflected in its almost equal (in absolute terms) contribution to the index returns. What is striking is the fact that the size factor explains more than half of the return of the small cap indices.
So yes, the rally is indeed small-caps driven.
For completeness the performance of the style factors over the last year can be seen in the Appendix below.
In this short note, we have explored the recent post-election small-caps rally and compared it with other significant recent developments on the market via the Cognity U.S. Fundamental Factor Model.
We can conclude that the recent rally is indeed small-stocks specific, and very much a reaction to the election, while at the same time the on-going value bias indicates that the investor expectations of a looming crisis have not yet been averted.
This is clearly seen via the style lenses of the U.S. Fundamental Factor Model, lending a significant degree of clarity to the impact of investment decisions.
The following charts show the last-year performance of all style factors from the Cognity US Fundamental Factor model.
Learn more about the BISAM Cognity's patented risk modeling capabilities: www.bisam.com/cognity