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The Size Factor Rollercoaster Ride Continued In Q3

FTSE Russell

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By Mark Barnes, head of investment research (Americas), and Marlies van Boven, head of investment research (EMEA)

Among our global factors, Size (smaller-cap) performance has been particularly sensitive to the shifting economic winds buffeting equity markets since the outbreak of the coronavirus this year.

The Size factor badly lagged globally in Q1, when widespread lockdown measures brought the global economy to a virtual standstill. It then strongly outperformed in Q2, benefiting from the resurgence in risk appetite as central banks and governments launched massive relief efforts and economies began to reopen.

Q2 2020 ‒ regional factor returns relative to broad-market indexes (LC, %)

Q2 2020 ‒ regional factor returns relative to broad-market indexes (LC, %)

Source: FTSE Russell. Data as of September 30, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.

But, while most equity markets continued to rally in Q3, Size struggled to gain ground, as fresh flare-ups in coronavirus cases has dented hopes for a quick recovery in the global economy. Investors continued to prefer the safe havens of Quality stocks, supported by positive Momentum.

Q3 2020 ‒ regional factor returns relative to broad-market indexes (LC, %)

Q3 2020 ‒ regional factor returns relative to broad-market indexes (LC, %)

Source: FTSE Russell. Data as of September 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

The Size factor remains a laggard in most markets year to date, particularly in the US and emerging markets, which (along with Asia Pacific) have now returned to positive territory.

Regional YTD Size returns relative to broad-market indexes (rebased, local currency %)

Regional YTD Size returns relative to broad-market indexes (rebased, local currency %)

Source: FTSE Russell. Data as of September 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Sector shifts play a major role

Sector composition explains much of the give-and-take in the relative performances between riskier Size and more defensive Quality this year.

Quality’s continued strength is the outgrowth of its large overweights in technology and health care, which have been steadfast outperformers in most markets this year. Quality is also significantly underweight financials, which have continued to badly lag for the year so far despite a Q2 rebound.

The opposite is true of Size: the factor is significantly underweight technology and health care, and overweight financials and other cyclically sensitive stocks that tend to perform best in periods of rising economic optimism.

Notably, the UK is the only equity market in which Size has outperformed this year. This reflects the recent weakening of the pound, which has favored domestic small-cap stocks, as we’ve noted in earlier blogs. It also partially comes down to divergences in sector exposures: versus global peers, UK Size is more heavily weighted to the industrials, materials and consumer services sectors, which enjoyed strong rebounds over the past two quarters and far less exposed to oil, which has been a major laggard over this period.

Balance-sheet health still keenly in focus

Quality has also greatly benefited from the persistent investor preference for the stocks of financially healthy companies with resilient business models, as reflected in the outperformance this year of measures of balance-sheet strength, such as high asset turnover and low accruals, and those of low leverage. In these uncertain times, investors desire the safety of stocks that can best weather the economic volatility ahead.

(Low) Leverage component returns relative to broad-market indexes – YTD 2020

(Low) Leverage component returns relative to broad-market indexes – YTD 2020

Source: FTSE Russell. Data as of September 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Originally Posted on October 14, 2020 – The Size Factor Rollercoaster Ride Continued In Q3

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