Equity Rally Takes A Defensive Spin In April

By Mark Barnes, Ph.D., and Christine Haggerty, Global Investment Research

The global equity rally that began last October made further headway in April, with most indexes adding to their robust first-quarter gains. Beneath the surface, however, big shifts in market and sector leadership reveal far more investor angst than these upbeat results may suggest.

As we cover in our latest Market Maps Performance Insights report, the UK, Japan, and Developed Europe outperformed the FTSE All-World index and their developed peers in April, particularly the US. The Emerging index fell, dragged down by steep selloffs in China and Taiwan. US small caps were the worst performers for both the month and the year so far.

Regional equity returns (TR %) – One month ended April 30, 2023

April leadership exposes defensive drift

Arguably, the strongest evidence of investors’ more cautious positioning was the huge U-turn among winners and losers in April from trends earlier in the year. Fueled mostly by the banking sector panic in March, technology, consumer discretionary and industrials outperformed in Q1, while financials plunged, as investors sought refuge in the stocks of financially healthy companies viewed as better equipped to withstand any potential economic and credit-market fallout. These Q1 growth outperformers also benefited from the sharp pullback in discount rates triggered by the crisis.

April turned this hierarchy on its head. Amid lingering worries about the US banking system and slowing global growth, investors abandoned tech and other growth stocks in favor of less cyclically sensitive stocks, such as those in personal care, food producers, household products, and drug makers, whose earnings tend to remain steady regardless of the state of the economy. Growth stocks were also hurt by Q1 earnings disappointments, while financials got a lift from stronger-than-expected quarterly results and waning worries about the global banking system (though those have flared again more recently.)

Regional industry returns (TR, LC) – One month ended April 30, 2023

These performance shifts filtered into the industry-weighted contribution to returns in the US, UK, and Developed Europe returns, as shown below.

Industry-weighted contributions to returns (TR, %) – One month ended April 30, 2023

The investor gravitation into defensive stocks also underpinned leadership among the major equity markets. The outperformance of the UK and Developed Europe indexes over their global peers owes much to their more diversified industry exposures and defensive tilts. The UK benefited significantly from its large exposures to outperforming staples, financials, and health care (see chart below), while largely avoiding weakness in tech stocks in April. Likewise for the Developed Europe index, in which financials and health care each make up 16%. By contrast, these winning industries made far smaller contributions to US returns, while the drawdowns in discretionary and industrial stocks were major drags.

Industry index weights (TR %) as of April 30, 2023

The underperformance of US small caps is further evidence of the more cautious currents sweeping through markets lately. As illustrated below, the strong investor preference for larger players in the banking, technology (software and hardware), and energy industries contributed most to Russell 1000’s edge over the small-cap index in March and April, overshadowing the impact of the latter’s far bigger weights in financials and health care.

Russell 1000 sectors’ relative returns vs Russell 2000 sectors (TR, rebased, LC)

The low Volatility factor also shines

Equity factor performance also displayed a more guarded tone in April: The Low volatility factor outperformed broad-market benchmarks and most other factors in most regions, especially versus post-pandemic champion Value. As we discussed in a recent blog post, in most markets, Quality did a complete 180-degree turn from its winning streak in Q1, hurt mainly by its large exposure to the sharp reversal in tech and other growth-tilted stocks.

Regional factor returns relative to home market (TR, local currency) – One month ended April 30, 2023

Thanks to its strong rebound in March and April, Low Vol returned to positive territory in most markets (except the UK) for the 12 months.

Regional Low Volatility factor returns relative to home markets (TR, rebased)

No one knows how long this cautious mood is likely to persist, but the newfound investor interest in defensive stocks seems a reasonable response to the extreme uncertainty currently looming over the outlook for the global economy and future monetary policy.

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