Podcast: Far from normal

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Welcome to 'RQI Investors Realinsights', your source for deep dives into quantitative investing. Now, before we begin, a quick note: what you're hearing right now is an AI-generated voice, bringing you insights from cutting-edge research conducted by the RQI team. It’s a fascinating reflection of the very principles RQI Investors embodies in their work. RQI Investors harnesses the power of human intelligence – the rigorous analysis and deep understanding you'll find in their reports – and combines it with sophisticated technology and data-driven models to navigate it’s complexities.

If you followed the equity markets last year, you likely felt like the ground was shifting beneath your feet. By almost any historical standard, 2025 has been an extraordinary, and at times, baffling year. We’ve seen multiple market regimes emerge and vanish in rapid succession, leaving even the most seasoned investors questioning their models.

Today, we are conducting a deep dive into our latest paper, "Far from Normal." This paper seeks to unpick the "abnormal" period we’ve just lived through—starting from the volatility following the 2024 U.S. election and the subsequent inauguration, right through to the dramatic policy shifts of the spring.

We’re going to look at the "Deepseek" shock that rattled the AI sector in January 2025. We’ll explore the period of intense risk aversion fueled by the threat of global trade wars. And most importantly, we’ll talk about “Liberation Day”—the early April pivot that sent markets into a tailspin before launching one of the most concentrated relief rallies in history.

If you’ve wondered why your "Value" stocks stayed flat while "Expensive" tech stocks doubled, or why the most hated, shorted stocks on the market suddenly became top performers, this episode is for you. We are looking at a market that is, quite literally, far from normal.

We identify four distinct phases or "regimes" that have defined 2025.

The first was the "Deepseek" moment in January. For a while, there’s been a joke in the industry that there are two bubbles: one in AI stocks and another in articles talking about AI stocks. But Deepseek shook the certainty of that AI juggernaut. It forced the market to realize that simply building larger, more resource-intensive models might not be the only path forward. This created a brief but significant moment of doubt in the tech sector.

Second, we entered a period of dramatic risk aversion. This was driven by proposed U.S. tariffs and the looming threat of global trade disruptions. Investors were terrified of sharp increases in U.S. inflation and a slowdown in global growth. This fear-driven regime rewarded "low beta" and "high quality" stocks while punishing anything volatile.

But then came the third regime: Liberation Day in early April. The administration essentially began a policy capitulation. Investors discovered that many of the much-feared "Liberation tariffs" were either just negotiating tactics or simply couldn't be delivered. By June, tariff arrangements had been negotiated with only eight countries.

This leads us to the fourth and current regime: The AI and Equity Market "Bubble." Once the fear of trade wars evaporated, it was replaced by a massive "risk-on" rally, fueled by an excessive extrapolation of AI productivity gains. It’s a regime defined by sharp risk-seeking behavior and an intense concentration in a handful of tech names.

Let’s look closer at the numbers surrounding that April pivot. The sell-off leading up to Liberation Day was marked, but the rebound was explosive.

In U.S. Dollar terms, the market hit its bottom on April 8th, 2025. However, due to fluctuations in the Australian Dollar and US Dollar exchange rate, the bottom for those of us looking at things in Australian Dollars wasn't reached until April 21st.

From that April 21st low point, the market surged. By December 1st, the MSCI World index was up by approximately 25%. The U.S. equity market, which had sold off even more sharply than the rest of the world, rebounded at a similar rate, proving that the relief was global but U.S.-centric in its origin.

It’s important to understand the psychology here. The fear of catastrophic policy implications drove the sell-off, and the backdown from those policies drove the rebound. We went from a defensive, "quality-at-any-price" mindset to an aggressive "risk-on" posture in a matter of weeks.

If you look at the sector-specific data, the story of 2025 is really the story of Information Technology.

Between January 1st and April 21st, the IT sector was down nearly 20%. But from the April bottom to December 1st, it skyrocketed by 46.2%. Communication Services saw a similar "V-shaped" recovery, bouncing 39.3%.

Compare that to more defensive sectors. Consumer Staples, which actually gained 7.6% during the fear-filled first quarter, fell by 2.1% during the subsequent rally. REITs were essentially stagnant, rising only 3.2% during the massive surge.

And then, of course, there are the "Mag 7." The returns here since April 21st are staggering. Google (or Alphabet) has returned more than 100%. Nvidia and Tesla both saw bounces of over 76%. Even Microsoft and Amazon were up 30% or more in that window.

Why is this happening? We believe there’s a few "non-fundamental" drivers. First, there's the Index Tracking flow. As passive index funds grow, they simply buy stocks at their market-cap weights. This means the biggest stocks—the tech giants—get a disproportionate amount of every new dollar, driving them higher regardless of valuation.

Second, there is a massive upswing in projected data center capex and the energy and resource needs required to support the AI boom. Investors are betting big on the infrastructure of AI, even as the "expensive" nature of these stocks reaches historical highs.

One of the most "abnormal" findings in this report involves the performance of heavily shorted stocks.

Usually, professional investors short stocks they believe are fundamentally broken. But in the post-Liberation Day world, the more a stock was shorted, the harder it bounced.

We analyzed data from FINRA and tracked the cumulative returns of the most shorted U.S. stocks. We found that a portfolio of the 50 most shorted stocks outperformed almost everything else during the rally.

Who were these winners? The list includes Bloom Energy, a fuel cell company that surged a massive 290% despite consistent short interest. Albemarle Corp, a lithium specialist, was up 50%, and even Reddit gained 20%.

This suggests that the "risk-on" environment forced a massive "reversion" of short positions. The "risk rally" wasn't just about buying what people loved; it was about the market aggressively punishing those who had bet against volatile names.

Now, many commentators have looked at these high-beta, high-short-interest moves and labeled this a "junk rally"—implying that low-quality, unprofitable companies were leading the charge.

But our data tells a different story. If you look at Return on Equity (ROE) as a proxy for quality, high-quality stocks actually outperformed low-quality stocks. Low ROE stocks have been largely flat since May.

The true anomaly isn't that quality failed; it’s that quality and high beta were joined at the hip.

Typically, quant models assume that a tilt toward quality involves a tilt toward lower risk and lower volatility. But for the second half of 2025, that wasn't the case. High-beta stocks outperformed low-beta stocks by more than 30% in a market that was only up 15% overall.

Furthermore, "Value" as a factor suffered immensely. "Expensive" stocks—those with the lowest earnings yields—dramatically outperformed "good value" stocks. It has been a world where being expensive and highly sensitive to market moves was the only way to generate significant alpha.

What about Size? Interestingly, this wasn't a broad-based "small-cap" rally. While the smallest stocks in the MSCI World universe rebounded, they didn't actually outperform the large caps. In fact, the Russell 1000 outperformed the Russell 2000 by about 4% over the year. This was a rally of the giants, not the underdogs.

So, what does this tell us about the state of investing today?

If you managed a strategy that remained underweight Tech, or if you had a strong tilt toward "Value" or "Low Volatility," 2025 was likely a very difficult year for you. The "tailwind" only existed for those willing to embrace high-quality, expensive, high-beta tech names.

We titled our paper "Far from Normal" to highlight that we are living through a period of extreme anomalies.

It is nearly impossible to predict these types of regime shifts in advance. While the AI euphoria and retail risk-seeking continue to drive the market today, historical factor performance—the rules of quality and value that have served investors for decades—should eventually revert.

Predicting when that happens is the great challenge. But as we’ve seen in every bubble and every anomaly throughout history, the four most dangerous words in the market remain: "This time is different".

Prudence suggests that while we recognize the current "risk-on" reality, we should be cautious about downweighting long-term, proven alpha factors in favor of chasing a trend that is, by definition, far from normal.

Thank you for joining us on RQI Insights. We hope this summary has provided valuable perspective on the market in 2025. For more detailed analysis, please refer to our full report, "Far from normal”, available on the RQI Investors website.

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