Professional Investors are familial with the Fama-French Factor model developed by Nobel Prize Laureate Eugene Fama with his colleague Kenneth French in the 1990s. According to this model, the expected return on a stock is the combination of the general equity market premium – the so-called beta of the single risk factor model – to which they added a “size premium” – on the premise that small cap stocks are expected to generate higher returns than large caps – and the value premium which is a reflection of a stock’s lower valuation compared to other stocks which trade higher on the basis of their expected earnings. This academic theory is at the heart of the so-called “smart beta” strategy based on ETFs – Exchange Traded Funds – which seek to replicate an exposure to the risk factors identified by Fama-French and by other pundits. However, since the beginning of the year, here have been a puzzling disconnect between “Growth stocks” and “Value stocks”.
Despite all the macro projections that tend to discard a V-shaped recovery, the markets seem for now to price in such a scenario, perceiving the profile of the current recession to be more similarities with the 1991 and the 2001 recession than with the more severe recession associated with the GFC in 2007-2008. The probability of a sudden reversal in market sentiment following some unexpected bad news looks increasingly high. An abrupt end to the ongoing euphoria should not be dismissed. Hedging this potential outcome by buying equity puts or VIX calls might be a good way to prepare for this eventuality while preserving the gains achieved during this unprecedented rally.
the economies of Mexico, Brazil, Russia, India, Indonesia, South Africa and Turkey have all been hit by the coronavirus crisis. EM currencies, equities and bonds have been particularly impacted by the global market fallout that occurred in February-March 2020. As has been documented by the IIF, Global investors pulled out their funds at record speed during that acute episode of market stress. Since then, the volatility of DM and EM markets has somewhat receded and the general sentiment toward risky assets has improved, not the least because the world’s major central banks committed trillions of dollars to support the markets and to put a de facto backstop on assets valuations . However, EM assets remains vulnerable to new waves of volatility and risk aversion that would trigger additional capital outflows.