2024 in Factors

Decomposing the market's return
 

By: Chris Satterthwaite & Lionel Smoler-Schatz

2024 was another stellar year for US equity performance, with the S&P 500 Total Return Index returning 25%, following a stellar 2023 performance of 26%.

Over these same two years, we have been hard at work building our own internal factor model here at Verdad to help decompose the drivers of return and volatility within global markets. We believe these types of factor models are instrumental for both making sense of the world (return and volatility attribution) and for building mean variance–optimized portfolios. With 2024 now behind us, we wanted to take a moment to reflect on what worked and what didn’t in 2024, using our factor model.

Below, we show the best performing equity factors in 2024, the volatility of the daily returns of those factors, the Sharpe ratio of each factor, and the comparison to the average over the last 30 years.

Figure 1: Equity Style Factor Performance

Source: Verdad Factor Model

Looking at some of the biggest drivers of returns, the global equity factor had higher returns and lower volatility versus the historical average. Similarly, the large size factor, high-investment (AI-driven), and high turnover (lots of trading activity) all did quite well for style factors. Momentum and quality did well but were largely in line with history while value lagged.

Within regions and sectors, the sectors were most notable, with financials, tech, and utilities excelling while consumer staples, materials, and health care all lagged historical factor returns.

Figure 2: Equity Region and Sector Factor Performance

Source: Verdad Factor Model

While equities had an outstanding year, they are (shockingly) not the only investable asset class. Below we show how a host of diversifying assets performed in 2024, as well as the comparison to the 30-year average.

Figure 3: Diversifying Asset Class Factor Performance

Source: Verdad Factor Model

Gold had an excellent year, with returns much higher than history, while US Treasurys lagged, with lower returns than the historical average. Within the foreign currency basket, almost all currencies depreciated against the dollar, leading to negative returns for owning foreign currencies.

While factor models can help make sense of the primary drivers of systematic risk and return, they don’t explain the entirety of returns. Factor models do a great job of explaining common drivers of variance in return across many stocks.

But what is particularly interesting about 2024 is how much of the S&P 500 return came from non-systematic (i.e., idiosyncratic) returns, driven by the significant appreciation of the “Magnificent Seven” (Mag-7), which now account for 35% of the S&P 500. Idiosyncratic returns are company specific and by definition should be uncorrelated and random. Below we show a factor-based return attribution for the S&P 500 for 2024.

Figure 4: S&P 500 Return Attribution

Source: Verdad Factor Model

The outperformance of the largest stocks in 2024, as evidenced by the outperformance of the S&P 500 (25%) versus the equal-weight S&P 500 (13%), shows how significant the idiosyncratic portion of return was in 2024. The idiosyncratic return from constituents of the S&P 500 amounted to 9% of the 25% total return.

In fact, idiosyncratic return has never contributed as significantly to the overall S&P 500 return as it has recently. Over the trailing 24 month period, idiosyncratic returns have accounted for 21% of the 51% return of the S&P 500.

Figure 5: Trailing 24M Idiosyncratic S&P 500 Return

Source: Verdad Factor Model

High idiosyncratic returns don’t necessarily bode poorly for the S&P 500, but it again highlights how dependent the index return has become on a handful of equities and how narrowly the winners are concentrated.

The magnitude of idiosyncratic return and the divergence between the cap-weighted and equal-weighted index highlight the importance of risk models. Owning the S&P 500 used to be an efficient way to get diversified exposure to US real GDP and corporate earnings growth. Today, investors in the S&P 500 get roughly 65% exposure to diversified US real GDP and corporate earnings growth and 35% exposure to the fortunes of the Mag-7.

Whether this is a better or worse deal for investors going forward remains to be seen. But risk models like the one we’ve built and discussed here are essential tools for knowing both explicitly and implicitly what sort of bets investors are making within their portfolios and understanding where their returns are coming from.