Defensive Quant Trades Are Headed for Best Month Since Covid Hit

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Regardless of whether the S&P 500 recovers from its miserable start to the week, systematic stock strategies are full of warnings that economic growth has already peaked.

An investing style that buys profitable firms with low debt is on course for its best month since the Covid-spurred market collapse last March, a Dow Jones index shows. Ditto a low-volatility trade beloved by quants during bouts of risk aversion. Investors have also been yanking cash from smart-beta funds that buy up stocks acutely tied to the economic cycle.

While the U.S. benchmark is only 2% off its record in the Tuesday rebound, the signals in the quant ecosystem give ammo to Wall Street bears fading reflation on bets that global growth is slowing down.

Defensive Quant Trades Are Headed for Best Month Since Covid Hit

“The narrative of ‘peak everything,’ in terms of earnings, macroeconomic momentum and policy approach, seems to be becoming a reality,” Julien Lafargue, chief market strategist at Barclays Private Bank, wrote in emailed comments. “This is happening at a time when the market’s ability to absorb setbacks looks limited as optimism is running high and valuations appear full.”

All this is lashing quant strategies sensitive to the business cycle that rallied in the first half as hopes for a global recovery took root.

Some of these risk-off moves reversed Tuesday as markets calmed, but since the start of summer, from product flows to performance, the mood has been decidedly more defensive.

In the $1.4 trillion world of smart beta -- exchange-traded funds pursuing quantitative trades -- investors have now pulled $2 billion from products following a value strategy in July. It’s poised to be the first monthly outflow in a year, and the biggest since at least January 2020.

At the same time, investors have put an almost identical amount into growth funds. These types of stocks -- which are less tethered to the economic cycle thanks to their long-term cash flows -- are booming again amid a slump in bond yields.

As doubts about the strength of the global recovery spread, the $28 billion iShares MSCI USA Min Vol Factor ETF (ticker USMV) has seen inflows three days out of four with no outflows in that time -- that’s the longest streak since May 2020 after a lengthy period of underperformance. That strategy tends to do better when rates fall, since it’s stuffed with stodgy bond-like stocks.

Meanwhile, a Goldman Sachs basket of U.S. shares with strong balance sheets is set to beat the opposite bucket for a seventh straight week. The iShares MSCI USA Quality Factor ETF (QUAL) has drawn nearly $1 billion this month -- set for the strongest inflows since March 2020.

“Declining markets and rising volatility usually fall hardest on high-beta/leveraged stocks,” Societe Generale SA quant strategists led by Andrew Lapthorne wrote in a note. “Credit risk-aversion is, for now at least, back on the priority list.

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