US short-horizon risk at 35-year low

Short-horizon risk in the US plunged to new lows last week, despite increasing political turmoil, uncertainty related to the new tax regime, and changes in the Fed’s governance, to name but a few of current investor concerns. Risk in the US had plummeted to at least a 35-year low in early August, before starting to climb as concerns about North Korea increased, only to begin ebbing once again in September. Last week US risk dipped even lower than the August record. Short-term risk was at 5.95% last Thursday, as measured by Axioma’s short-horizon fundamental US4 Model. US risk has dropped over 300 basis points year to date, falling by nearly 80 points in the last six months. The decomposition of the change in risk from the factor model reveals that factor volatility drove all of the decline in risk over the past week, month, three and six months. In general, the magnitude of the decrease in risk was reduced slightly over all four horizons by the changes in other components of risk: index composition, stock characteristics, stock specific volatility, and factor correlations. When we decompose the change from the point of view of an asset-asset covariance matrix, however, it was the sharp drop in asset correlations that drove the decline almost exclusively.

China’s stock market continued to ascend after its new leadership team was named at the end of October. China’s six-month return neared 20% last Thursday, making it the top performer among both emerging and developed countries. China’s market risk followed a downward trend in 2017 up to the beginning of August when it reached a 17-year low of 8.5%, as measured by Axioma’s short-horizon fundamental Worldwide model. Risk has increased marginally since then and was around 10.5% last Thursday.

Dispersion—the cross-sectional standard deviation of weekly returns—increased steadily in FTSE Developed over the past five weeks. The wider the dispersion, the more opportunity for active managers to add value in this region. At the same time, winning stocks in FTSE Developed dominated losers in the index for eight consecutive weeks. The US, Canada, Japan, and Australia also exhibited a similar pattern of increased dispersion, with winning stocks exceeding losing ones. In contrast, Emerging Markets and Developed Europe saw asset dispersion shrink as of last week.

If you’d like to get timely insights emailed directly to you, please sign up for our weekly newsletter.

Melissa Brown, CFA

As Managing Director of Applied Research, Melissa Brown generates unique insights into risk trends by consolidating and analyzing the vast amount of data on market and portfolio risk maintained by Axioma. Brown’s perspectives help both clients and prospects to better understand and adapt to the constantly changing risk environment.