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Why Size Matters

Policy Post Mortems

Global Inflation Beta

HOT PORK ROLLS

A Week of Auctions and Announcements

Why Size Matters

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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This morning’s Financial Times revisits the argument that smaller funds generally have a performance advantage over larger funds.  One contention advanced in favor of this view is that as funds grow, they “have” to hold more large-cap stocks, and that this large-cap weighting hurts overall performance: “Outperformance in large-cap companies is harder to achieve because they are more efficiently priced.”

Not exactly.  Increasing a fund’s weighting in large caps actually produces two distinct effects which should not be conflated.  The more important of the two is an allocation effect: if large caps, as an asset class, do less well than mid- or small caps, then increasing a portfolio’s exposure to the large-cap segment of the market is likely to diminish its performance over time.  In this absolute performance sense, the argument against large caps is well-established; the Fama-French study of 1992 is probably its most famous, but by no means its only, exposition.

But adding large-cap stocks also produces what we might call a relative performance or selection effect; if it’s easier to generate excess returns (“alpha”) in small-cap stocks than in large, then performance might suffer for that reason as well.  That’s the argument of the FT‘s source, and on first blush it’s plausible.  It’s certainly true, e.g., that research coverage is tilted toward larger companies.  And the dispersion of mid- and small-cap stocks is greater than that of  large caps, which tells us that the opportunities for alpha-generating stock selection diminish as we go up the capitalization scale.

But higher dispersion, and the scarcity of research coverage, imply only that the likelihood of misvaluation is higher among smaller companies.  There’s no reason to assume that the likelihood of undervaluation is higher for small caps than large caps, and without that presumption the case for active management of small-cap stocks withers.  Logically, of course, the average component of any index can’t be either over- or under-valued relative to the index’s valuation level — there is, in other words, no net supply of alpha.  And the empirical data demonstrate that generating excess returns relative to an appropriate index is just as difficult for small- cap managers as it is for large.

Size matters because small- and mid-cap stocks, over time, tend to outperform large caps.  But when it comes to stock selection, the average small- or mid-cap investor, like his large-cap counterpart, would benefit from a passive approach.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Policy Post Mortems

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Complete transcripts of the Fed’s policy meetings and conference calls are published with a five year lag. Last week the central bank released the transcripts from 2008, probably one of the more interesting years to “hear” word for word what the members of the FOMC were saying.  The release was almost to the day the five year anniversary of the signing of the American Recovery and Reinvestment Act – better known as Obama’s stimulus — on February 17th 2009.  These two events are generating discussion of both monetary and fiscal policy over the last few years along with a lot of Monday morning quarter-backing.

If journalism is instant history, then journalism with a five year lag is certainly not history written with sufficient time to digest events and gain perspective.  Recent comments about both the Fed and the fiscal stimulus reflect current policy debates more than anything else. The comments also demonstrate that most of us have forgotten how dark the economy and the markets looked as Lehman collapsed and Congress rejected the first attempt to pass legislation to address the crisis. While acknowledging that we don’t yet understand everything that happened to the economy or why, it is still possible to draw a few conclusions with some possible pointers should such things happen again.

On the fiscal policy side, leaving aside the claims that fiscal policy doesn’t work, that it would have worked if it had been larger or that it did work because without we would have had a second Great Depression, a little bit of data:  The US stock market bottomed out and turned up on March 9th 2009, about three weeks after the stimulus bill became law. US real (inflation adjusted) GDP quarter to quarter at annual rates were -8.3% in 2008:4, -5.4% in 2009:1, -0.4 in 2009:2 and +1.3% in 2009:3.  Job losses bottomed in the first quarter of 2009 and were positive by the end of the year.  In the numbers, the fiscal stimulus worked.  There was a very deep recession but no second Great Depression.  It is too early to give fiscal policy and the stimulus law a final grade, but it certainly passed and made a large positive contribution.

The Fed transcripts run about 1500 pages including meetings, phone calls and supporting documents.  The number of commentators who have read through all the documents is probably very small (and does not include me).  From the selections reported and repeated in the media and among blogs, one hears of moments of great insight as well as surprise, shock and sometimes scant comprehension of what was happening.  A few things that were learned, and shouldn’t be forgotten, include: what absolutely can’t happen sometimes does, it is difficult to forget or eliminate yesterday’s fears (such as inflation) and just because something hasn’t been done before is not a reason to not do it.  In the end the Fed recognized the liquidity had vanished, that the solvency of many major institutions was being questioned and that no one would accept any risk. The central bank took steps to address these issues with the focus on liquidity and risk by pushing interest rates to zero and flooding the market with liquidity. The resulting rise in asset prices helped address some of the solvency problems. Inflation, five years later, is lower now than it was iat the beginning of 2008.  Through the comments echoed in the media both Chairpersons – Ben Bernanke and Janet Yellen – come across as having understood the problems as quickly as anyone while maintaining a sense of perspective and humor.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Global Inflation Beta

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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It is a familiar concept that commodities have provided inflation protection as discussed in a recent post about a discussion I had with Bluford Putnam, Managing Director and Chief Economist, of our partner, CME Group, to discuss why inflation is likely to appear this year.

I have also discussed how much inflation protection has been provided in a special video on commodities and inflation from our Index Matters Series with Bob Greer of PIMCO and Boris Shrayer (formerly) from Morgan Stanley.

Inflation and commodities generally move together as shown in the chart below:

Source: S&P Dow Jones Indices and/or its affiliates and ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt  Data from Jan 2004 to Dec 2013. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.
Source: S&P Dow Jones Indices and ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
Data from Jan 2004 to Dec 2013.  Past performance is not an indication of future results.
This chart reflects
hypothetical historical performance. Please note that any information
prior to the launch of the index is considered hypothetical historical performance (backtesting).
Backtested performance is not actual performance and there are a number of inherent limitations
associated with backtested performance, including the fact that backtested calculations are
generally prepared with the benefit of hindsight.

However, in light of the inflation announcement from Feb 20, 2014 that stated US inflation ticked up in January 2014, I have received some questions from investors around the world regarding whether the commodity indices protect them from local inflation.  The answer is that it depends but for most of the countries in the table below, the answer is yes.  As I have explained inflation beta in prior posts, the results can be interpreted as, “if there was a 1% change in CPI, then there was an x% change in the index”.

In the table below, the country CPI is compared to both a global flagship, the S&P GSCI, and an international flagship the S&P WCI.  Notice generally the inflation beta is higher from the international benchmark, the S&P WCI.  Also notice for some countries like South Africa and Mexico, there may not be the local inflation protection one might get from other countries. This is not completely surprising given that some countries have local price controls despite the global nature of commodities, discussed in this post including discussions with the CME Group, ICE and NYSE-LIFFE.

Source: S&P Dow Jones Indices and/or its affiliates. Data from Jan 1973 to Feb 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.
Source: S&P Dow Jones Indices. Data from Jan 2004 to Jan 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please note that any information prior to the launch of the index is considered hypothetical historical performance (backtesting).  Backtested performance is not actual performance and there are a number of inherent limitations associated with backtested performance, including the fact that backtested calculations are generally prepared with the benefit of hindsight.

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.

HOT PORK ROLLS

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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For any investor who has chosen lean hogs as the commodity to invest in 2014, s/he is as “happy as a pig in the index“. The S&P GSCI Lean Hogs are the 3rd best performing commodity in the index YTD, up 16.3%, before the roll.  Even after the roll, the lean hogs are the 5th best performing commodity in the S&P GSCI and the best performing commodity in its sector, livestock. Now the  S&P GSCI Lean Hogs is just 4.5% short of reaching its all-time index level high which occurred in March 2011.  

Source: S&P Dow Jones Indices and/or its affiliates. Data from Jan 1973 to Feb 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.
Source: S&P Dow Jones Indices and/or its affiliates. Data from Jan 1973 to Feb 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.

Rising expectations that cash hog supplies will tighten soon and an increase in wholesale-pork prices have supported the lean hogs in the index. Packers were willing to pay higher prices to insure their immediate slaughter needs (known as convenience yield) were covered as they attempt to catch up production in the wake of weather-induced closures and delays (known as expectational variance or supply shocks). Summer hog contracts remain strong on the expectation Porcine Epidemic Diarrhea virus (PEDv), which is fatal to baby pigs, will cut the U.S. hog herd.

Average monthly returns between Jan-Feb of 2014 of 7.9% are the highest of any first two months since 1999. Further, the average monthly summer backwardation in 2013 of 4.2% was the highest since 2001 and has been increasing since 2010, when it was just 1.9%.  Also in history, only in 14 of 39 years have we seen  backwardation in February and we haven’t seen three years in a row with a backwardated February, like we see now, since 1978-80. 

In the summer months of June-Sept, during the years of backwardation in February, the average monthly total return of lean hogs was 117 basis points higher than in all the years taken together. If this pattern continues with tight supplies of lean hogs, there could be a hot roll this summer. Though one might be cautious given the history of abundance in March.

See in the charts below the data showing historical average returns, backwardation and contango.

Source: S&P Dow Jones Indices and/or its affiliates. Data from Jan 1973 to Feb 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.

Source: S&P Dow Jones Indices and/or its affiliates. Data from Jan 1973 to Feb 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.
Source: S&P Dow Jones Indices and/or its affiliates. Data from Jan 1973 to Feb 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.
Source: S&P Dow Jones Indices and/or its affiliates. Data from Jan 1973 to Feb 2014. Past performance is not an indication of future results. This chart reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.

 

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.

A Week of Auctions and Announcements

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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The S&P/BGCantor Current 10 Year U.S. Treasury Bond Index closed last week up 0.12%.  January’s Housing Starts number of 880k fell well below the 950k expected number and the prior revised level of 1048k pushing Treasuries up for the week.  The question was how much of the number was due to harsh winter weather or whether a slower economy might be a factor.

The Treasury will be coming to market with supply of 2’s (both floating & fixed), 5’s and 7-year notes. The $109 billion in debt will be auctioned this week.

This week will bring more housing and economic information.  Already U.S. Treasuries are slightly down in price as the Chicago Fed National Activity Index reported a -0.39.  The expected number was -0.20 and the prior December number was a 0.16 which later was revised down to -0.03.  The Dallas Fed Manufacturing Outlook reflected the same sluggishness in the economy as February number was a 0.3 versus a prior 3.8.  Tomorrow’s House Price Index release along with the S&P/Case-Shiller Home Price Index should add insight on top of last week’s Housing Starts number.  Also due to be release this week, outside of housing indicators, will be Durable Goods, Initial Jobless Claims, GDP information and the University of Michigan Confidence Index.  Each and every one of the numbers has the potential to shed more transparency on the overall strength of the economic recovery.

Very little curve movement for this month has the S&P U.S. Issued Investment Grade Corporate Bond Index returning only 0.22% for the month.  The OAS (Option-Adjusted Spread) of the S&P U.S. Issued Investment Grade Corporate Bond Index is pretty much unchanged for February, while in January they were tighter by 8 basis points.  The BBB rating sub-index has tightened in both January and February as moving back down in credit to gain yield has picked up again.

The performance of high yield as measured by the S&P U.S. Issued High Yield Corporate Bond Index reflects the need for yield.  The index is returning 1.26% for the month and 2.03% year-to-date.  The loans in the S&P/LSTA U.S. Leveraged Loan 100 Index have not kept pace with the longer duration high yield index as loans returns 0.04% for the month and 0.65% year-to-date.  Though, a reversal in the direction of rates could change the story very quickly when comparing loans to high yield.

 

Source: S&P Down Jones Indices, Data as of 2/21/2014, Leverage Loan data as of 2/23/2014.

The posts on this blog are opinions, not advice. Please read our Disclaimers.