- Historically, a U.S. rate-hike pause or pivot saw all factors but momentum outperform in the six months following the last rate hike, while communication services, consumer staples, financials, health care and utilities did well.
- The MSCI ACWI Index was up 6.3% in the second quarter of 2023, as developed markets outperformed while China weighed on emerging markets.
- The MSCI Adaptive Multi-Factor Allocation Model pointed to an overweight to value as of June 30, 2023.
In the second quarter of 2023, the MSCI ACWI Index gained 6.3%, extending the year-to-date gain to 14.3%, led by strong earnings from the technology sector. Among a universe of 3,014 stocks, only about 26.5% outperformed the index in the year to date, making it a challenging environment for active managers. The "Magnificent Seven" (Apple Inc., Microsoft Corp., NVIDIA Corp., Amazon.com Inc., Meta Platforms Inc., Tesla Inc. and Alphabet Inc.) contributed more than 50% of index returns (close to 70% for MSCI USA Index), reflecting the concentration of outsized returns in mega caps.
Several questions remain on the minds of investors. Does the outlook for earnings-per-share (EPS) growth reflect a soft landing, hard or perhaps rocky landing? How have analysts responded, and have the revisions in their EPS predictions been fully reflected in valuations? And considering inflation remained higher than many expected at the beginning of the year, how might equities respond to interest rates’ remaining higher for longer or potentially pivoting? We look to address these questions in this blog post, as well as highlight recent trends across global markets.
What to watch with forward-EPS growth close to historical lows
At a global or regional index level, analyst outlook for EPS continued to signal caution. EPS growth among stocks in the MSCI ACWI Investable Market Index (IMI), MSCI World Index, MSCI USA Index and MSCI Europe Index were at the lower end of their respective ranges going back almost 30 years. This could reflect the weak realized-EPS growth over the last 12 months and economic concerns. If a hard landing becomes less likely, analysts may look to revise their expectations. Investors that have followed analyst sentiment for securities selection, measured by revisions in predicated EPS, have continued to be rewarded; in fact, more so over the last 12 months.
Analysts’ EPS expectations and performance of hypothetical portfolio following their revisions
The plot shows the comparison of trailing 12-month EPS growth rate and one-year forward expected EPS growth rate for various regions, along with the performance of a hypothetical decile-spread portfolio (long top decile, short bottom decile) of the change in analyst-predicted EPS descriptor. Data from December 1994 to June 2023. Charts are generated over the MSCI ACWI IMI universe of each region.
Market indicated US interest rates could remain higher for longer
There had been a notable shift in market sentiment regarding the pace at which interest rates may decline in the future. As of May 12, one-month forward rates for futures contracts on the USD secured overnight financing rate (SOFR) indicated an anticipation of swift rate cuts, as evidenced by the steep slope of the rate curve. But between then and the June 14 Federal Reserve meeting, the market adjusted its expectation of rates upward, indicating the sentiment that rates would increase for the next several Fed meetings and then starting to decline as we approached the first quarter of 2024. This shift in sentiment, which continued to adjust upward in the weeks following the meeting, may be attributed to inflation remaining at elevated levels and the presence of robust economic data. These factors might be putting pressure on the Fed to maintain higher rates for an extended period.
Implied one-month forward SOFR rates (%)
Source: MSCI USD SOFR futures curve
How have indexes responded to previous rate-cycle pauses and pivots?
Regardless of when it comes, the possibility that the U.S. rate-hike cycle might be coming to an end may have implications on the broader equity market, as well as on individual factors and sectors. With that in mind, we analyzed historical data to check how the MSCI USA factor and sector indexes have responded to such a change six months after the last hike or cut, depending on whether the Fed kept rates steady or reversed direction over that six-month period.
As shown in the exhibit below, we found that all factors except momentum have outperformed in the six months following the last rate hike, with high dividend yield leading the charge. For sectors, information technology has been extreme in either direction depending on whether the Fed paused or pivoted, while communication services, consumer staples, financials, health care and utilities have done well in both scenarios.
Historical factor performance six months after the “last” rate hike
Data from September 1982 to June 2023. Source: Federal Reserve Bank of St. Louis’s FRED database
US and Japan outperformed among developed markets; China offset Brazil and India’s returns within EM
Reviewing performance through the lens of MSCI indexes over the second quarter of 2023, we see that, overall, quality did well in with the U.S., while the momentum and value factors have done better in emerging markets and Asia. Mid-cap stocks underperformed in all regions. With the increasing expectations of artificial-intelligence (AI) adoption in business processes, stocks related to AI saw strong performance, which was also visible in the outperformance of most of the MSCI indexes within the transformative-tech thematic category. Through June of this year, the robotics and AI theme outpaced the broad-market MSCI ACWI IMI by its widest margin since inception (shown below).
Relative return of the MSCI ACWI IMI Robotics & AI Index
Returns are for the MSCI ACWI IMI Robotics & AI Index in gross USD from December 2016 through June 2023, relative to the MSCI ACWI IMI.
In terms of regional performance, developed markets outperformed emerging markets, led by Japan (+6.4%) and the U.S. (+8.7%). Weak manufacturing and consumer-spending numbers in China reported in May led to the underperformance of the MSCI China Index (-9.6%), which weighed heavily on the performance of the MSCI Emerging Markets Index, which otherwise was good, given strong performance from India (+12.4%) and Brazil (+20.8%).
Technology-oriented thematic indexes led in Q2 2023
The table shows regional variations of market-cap and non-market-cap MSCI indexes from March 31, 2022, to June 30, 2023. The bar chart shows the active returns of the same indexes, by region, for each month in the quarter, as well as for the full quarter.
MSCI Adaptive Multi-Factor Allocation Model
Our adaptive multi-factor framework is a model designed to analyze factor-based decisions. Our research suggests the value in taking a holistic approach to factor assessment. This approach encompasses not only the macroeconomic environment as shown above, but factor valuations, recent performance trends and risk sentiment.
As of June 30, 2023, the MSCI Adaptive Multi-Factor Allocation Model showed an overweight to value, relative to an equally weighted factor mix (as shown below).
Exposures from MSCI Adaptive Multi-Factor Allocation Model
Data as of June 30, 2023. Positive exposures are denoted as + or ++, negative as - or -- and neutral as N.
Further Reading
Markets in Focus: Looking Beyond the Rate Hikes webinar
'Magnificent Seven’ Drove the Equity-Market Rally
Macro Scenarios: Resilient US Economy but Downside Risks Loom
Markets in Focus: Factor Valuations and the New Rate Regime
Markets in Focus: Investors Look to Capture Big Market Shifts