Is the Market Ripe for Stock Picking?

Through cross-sectional dispersion of stock-specific returns, we see that the opportunity for active managers to outperform the market through stock selection has increased over the past 12 months (as compared to the prior two years). Cross-sectional dispersion of returns measures volatility across equities over a single period. Total cross-sectional dispersion can then be decomposed into different sources of risk, including country/market, industry, style factors and stock-specific risk.

The intensity of dispersion

The ratio of dispersion resulting from stock-specific factors as a percentage of the total has increased over the past year relative to the prior two years. Generally, if this dispersion is low, then most stocks behave similarly, leaving limited opportunity for active managers to outperform the market through stock picking. Conversely, when dispersion has been relatively high, opportunities for stock selection have increased potential.

Market influence has diminished

Different equity-market segments, including the U.S., world ex U.S. and emerging markets, as well as varied size segments within these markets, are representing increased opportunities for active managers to outperform the broader market. One explanation for this is the broader equity market’s waning influence in driving the performance of individual stocks. In fact, according to MSCI USA Index data, the U.S. market had been the driver of more than 40% of the cross-sectional dispersion when it peaked in early 2021, but that is now down to nearly 20% as of the end of May.