If the coronavirus continues to spread and triggers widespread fear, historical performances suggest that high-momentum and low-volatility factors and related exchange traded funds could take the lead.
“If the contagion results in a fear-scenario similar to either 9/11 or the Chinese equity crisis that investors might want to tilt towards high-momentum and low-volatility stocks,” Damian Handzy, Chief Commercial Officer of StyleAnalytics, and Elie Salman, Client Consultant for StyleAnalytics, said in a research note. “Since the biggest impact of this virus will almost certainly be to the Chinese economy, the protection that Low-Vol provided during the last Chinese equity crisis suggests a defensive strategy for factor investors as the world watches this latest crises unfold.”
StyleAnalytics warned of the potential that the coronavirus could mutate, causing high contagion with high mortality, which could trigger a global financial contagion. Consequently, in this type of environment, high momentum and low volatility factors have historically outperformed.
“While it may seem ghoulish to be looking for ‘crisis alpha’ in the wake of the Coronavirus outbreak, the reality is that every advisor is going to field questions from their clients about how to respond to this new and rapidly evolving risk,” said Dave Nadig, CIO of ETF Trends. “This analysis from Style Analytics highlights how hard it is to try and reposition around uncertainty, and should be required reading for anyone before they start talking to clients about factor exposures in the first quarter.”
StyleAnalytics argued that the coronavirus may play out differently when compared to how the market reacted to other recent health crises, like SARS, the Avian Flu, the Swine Flu and MERS, among others. Specifically, coronavirus is exhibiting low mortality rates and high contagion rates, so the risk now is over-reaction by the government and the public. However, if the contagion mutates and ramps up, it has the potential of growing into something like the Spanish Influenza that killed 50 million or 3% of the world population at the time.
Consequently, StyleAnalytics tried to draw comparisons to other global crisis level events, like the Chinese equity crisis, the terrorist attacks on September 11 and the global financial crisis. After 9/11, momentum outperformed. During the Chinese equity crisis, low-volatility stocks outperformed.
“Low-volatility stocks give an antidote to uncertainty, resulting in a ‘flight to quality’. Behavioral economists remind us that people tend to follow recent returns as if they are indicative of future returns. The premium earned by high-momentum stocks is consistent with this view,” according to StyleAnalytics.
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