Indexology^® Blog

A recently published paper  received a fair amount of publicity for its suggestion that portfolios selected randomly by monkeys would have outperformed a capitalization-weighted index of the same universe.  In recent years it seems like everyone is bashing cap-weighted indices, so it was probably only a matter of time until apes took a shot. Maybe pigs and dolphins are next.

The problem with this analysis is that the monkeys formed their portfolios by choosing stocks so that each stock (of 1000 in the test universe) had an equal likelihood of being selected and/or overweighted by each monkey. This more or less guarantees that the monkeys’ portfolios, perhaps with a very few exceptions, will have a small cap bias. In a period when we know that small size paid off, it’s not surprising that the monkeys outperform cap weighting.

One of the virtues of a cap-weighted index is that it accurately reflects the nature of the investor’s opportunity set. Otherwise said, the world is cap-weighted. An investment dollar chosen at random is not equally likely to be invested in Apple Computer as on the smallest stock in the universe. It is much more likely to be invested in Apple. The monkeys presumably did not know this, and thus, in a particular way, behaved anything but randomly.

Simple juxtapositions can sometimes produce insight, or so at least runs the theory behind our just-introduced monthly U.S. index dashboard: http://us.spindices.com/documents/commentary/dashboard_032813_2914.pdf. For the first quarter of 2013, e.g., we can observe that:

• The equity markets were very strong (no revelation there), with both the Dow Industrials and S&P 500 both up more than 10% and at record levels by quarter-end.
• Strangely for such a strong quarter, defensive indices outperformed the general market. S&P 500 Value topped both S&P 500 Growth and the S&P 500 (granted by only a whisker in the latter case). More interestingly, such defensive stalwarts as S&P High Yield Dividend Aristocrats and S&P 500 Low Volatility came in well ahead of the S&P 500.
• This pattern also turned up at the sector level. For the quarter, the best performing S&P 500 sectors were Health Care, Consumer Staples, and Utilities, all of which strike a defensive note.

With both short- and long-term interest rates in the basement, income-sensitive investors have naturally begun to look to equities.  Significantly, the yield on the S&P 500 now exceeds that of the 10-year U.S. Treasury bond – a relationship last seen in approximately 1958.  But if some equity yield is good, does that mean that more equity yield must be better?  Not necessarily – we recently identified some of the opportunities and pitfalls for investors seeking income beyond bonds: http://us.spindices.com/documents/research/research-income-beyond-bonds.pdf

Three of the Five Cities Saw Default Rates Descend in February 2013

New York, March 19, 2013 – Data through February 2013, released today by S&P Dow Jones Indices and Experian for the S&P/Experian Consumer Credit Default Indices, a comprehensive measure of changes in consumer credit defaults, showed a decrease in national default rates during the month. The national composite was 1.55% in February, down from 1.63% in January.

The first mortgage default rate moved down to 1.48% in February, from 1.58% in January. The bank card rate was 3.37% in February vs. 3.41% in January. The second mortgage and auto loan default rates increased in February posting 0.71% and 1.11%; they were marginally up from their respective 0.69% and 1.10% January levels.

“Consumer credit quality remains healthy”, says David M. Blitzer, Managing Director and Chairman of the Index Committee for S&P Dow Jones Indices. “The first mortgage and bank card default rates moved down, the second mortgage and auto loans were marginally up in February. All loan types remain below their respective levels a year ago.

“These trends are consistent with other economic news – improvements in employment and overall economic activity and continuing gains in housing. Additionally, foreclosure activity continues to decline even though it remains at elevated levels compared to the period before the financial crisis.

“Three of the five cities we cover showed decreases in their default rates in February – New York was down by 12 basis points, Los Angeles by 18 and Miami by 24 basis points. Chicago was marginally up by one basis point and Dallas was up by seven basis points. Miami had the highest default rate at 3.21% and Dallas – the lowest at 1.26% among the five cities. All five cities remain below default rates they posted a year ago, in February 2012.”

The table below summarizes the February 2013 results for the S&P/Experian Credit Default Indices. These data are not seasonally adjusted and are not subject to revision.

The DJ-UBS CI Energy Subindex is the best performing sector in the index, up 2.2% this week contributing to a 3.2% MTD return and 4.0% YTD return.  Although the International Energy Agency’s (IEA) projection of 820 kb/d annual growth in global oil demand for 2013 is less than the 1.4 mb/d growth average for non-recessionary years from sluggish economic signals, the DJ-UBS CI Natural Gas, gained 6.1% this week, bringing the month’s return to 9.0% and YTD to 9.9%. The Energy Information Administration (IEA) reported a drop in U.S. inventories that was bigger than expected based on cold weather and above-average nuclear power plant outages, which kept the momentum to the upside.

Driven by solid mill buying and U.S. exports, the DJ-UBS CI Cotton gained 5.0% this week, bringing its YTD return up to 19.5%. It is the best performing commodity in the index this year. The U.S. Department of Agriculture (USDA) has forecast a record global surplus, but most of those reserves are expected to be within China’s stockpiles and unavailable to the global marketplace. The International Cotton Advisory Committee (ICAC) stated China’s cotton reserve has continued to expand at “a ferocious rate” and is projected to reach 8 million metric tons (36.74 million bales) by the end of the 2012-13 marketing year.

The DJ-UBS CI Corn and DJ-UBS CI Wheat have also been strong performers recently.  A weaker U.S. dollar supported both of these grains but the DJ-UBS CI Corn, up 3.7% for the week and 1.9% MTD, was driven by tight old-crop supplies, while the DJ-UBS CI Wheat rose 4.2% this week and 1.4% MTD, driven by high demand from livestock feeders.