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The Fed’s March Rate Decision Could Determine If This Week Is A Lion or A Lamb For Bonds

Touching Clovers Is Like Gold, Not VIX

Recent Interview: Commodities To Upstage Stocks

A Bang not a Whimper

Some Inconvenient Truths

The Fed’s March Rate Decision Could Determine If This Week Is A Lion or A Lamb For Bonds

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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  • Treasuries closed the week returning 1.32% as measured by the S&P/BGCantor Current 10 Year U.S. Treasury Bond Index.  The index is now returning 0.18% for the month and 4.13% year-to-date.  Continued concerns over the Ukraine political situation may have led to a demand for Treasuries as a flight to safety trade.  The auctions of $64 billion of 3-, 10- and 30-year debt were successful in the current environment.
  • The week ahead for economic numbers started today with March’s Empire Manufacturing which at 5.61 was lower than the expected 6.5.  Tomorrow’s CPI number is widely expected to be unchanged from its prior levels.  It still remains to be seen if any recent weakness in the economy has been due to the harsh winter and if the markets should have more confidence in the Fed’s view of underlying strength in the economy which led to the decision to continue taping its stimulus buying.  Wednesday’s FOMC Rate Decision along with Friday’s Philadelphia Feb Business Outlook (4.0 expected) and the Leading Index (0.2% expected) should provide more clarity.
  • It’s too early in the month to tell how it will end but when compared to January and February, the S&P U.S. Issued Investment Grade Corporate Bond Indexis off to a negative start in return as the index is down -0.04% for the month.  The March 3rd, year-to-date high of 3.15% had eroded down to 2.09% but since then has been climbing back to its current 2.82%.  Investment Grade debt issuance has been active.  Timing the sale of debt before any significant rise in rates may be the underlying motivator of this trend.  The past week saw the pricing of numerous deals including names such as Coca-Cola, Citigroup, General Electric, Burlington Northern, Royal Bank of Canada and Viacom to name a few.
  • The high yield market also saw its share of new issuance over the past few weeks as deals like Access Midstream, Pioneer Energy, Tenet Healthcare and many more came to market.  The S&P U.S. Issued High Yield Corporate Bond Index closed the week down -0.11%.  Like investment grade bonds, the high yield index’s year-to-date return peaked on March 5 at a 2.77% but has yet to recover, presently at a 2.4%.
  • The S&P/LSTA U.S. Leveraged Loan 100 Indexis returning 0.19% for the month and 0.86% year-to-date.  The index has reached a year-to-date high for 2014 at 0.86%; the prior high was 0.74% on January 22.  The market held steady throughout the week as the recent outlook has improved with new deals such as Rite-Aid, Ellucian, Zuffa, and Spirit Aero.  Prior to 2008, the weighted average price of the S&P/LSTA U.S. Leveraged Loan 100 Indexaveraged 98 between 2001 and 2007.  Because of the financial crisis of 2008, the price dropped to a low of 59.20.  Since December 17 of 2008, the weighted average price of this index has risen 66% to its current level of 98.41.

 

Source: S&P Dow Jones Indices, Data as of 3/14/2014, Leveraged Loan data as March 16, 2014.

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

Touching Clovers Is Like Gold, Not VIX

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Thus far on the blog, we have written a few pieces about busts in the stock market. David Blitzer wrote, “Whenever this bull market ends, it is likely to be with a bang, not a whimper.” He also wrote about Deflation, Debt and Disaster where he pointed out we may be on the edge of deflation, which leads to stagnant economies and depression. I also pointed out the cycle of stock-to-commodity outperformance may be switching back in favor of commodities.

With the possibility of doom and gloom over the stock market, a natural question may be where to turn to protect your assets. Many consider gold a safe-haven, but is it really? My colleague, Reid Steadman, wrote about VIX – The Enforcer, where in a hockey analogy he pointed out that when other markets fail, VIX may be the last line of defense.  It is a decent argument that VIX may act as a strong safe-haven.

However, many might be hesitant to believe that VIX, a reflection of volatility, is a safe-haven since it’s not tangible. Despite the fact that not even the luckiest person can catch the leprechaun with the pot of gold at the end of the rainbow, at least everyone can dream that picture.  But what does a pot of VIX look like? Besides charts in a pot?

Although Reid does a good job of explaining what is VIX, as humans we possess irrational behaviors (besides believing we can catch a leprechaun with a pot of gold).  One of our behaviors is biased expectations or overconfidence that leads to misapprehensions about oneself and to the illusion of control.

In a published card game example, investors are more confident in the value of the cards they TOUCHED. The example is as follows:

  • A game is played with two decks of cards, red and blue.  Players pay $1 and receive one card from one of the decks. The card is then returned to the deck, the dealer shuffles and draws one card. If the player’s card is drawn, the player wins $100.
  • When the game is played with the blue deck, the dealer only shows the card to the player.
  • When the game is played with the red deck, the player gets to touch the card and return it to the dealer.
  • Players were asked to sell their cards prior to revealing the card chosen by the dealer.

The results show players valued the cards they touched more than they valued the cards they did not touch:

  • Blue deck (no touching of cards): 19% were unwilling to sell their cards. Average asking price was $2
  • Red deck (players were able to touch cards): 37% were unwilling to sell their cards. Average asking price was $9

Why does this matter?  It is since investors may value the tangible property of gold as a store of value, or currency, that it has been considered a safe-haven asset as throughout history. But the question is at what price? Is gold as a safe-haven really more valuable than VIX at protecting your portfolio in hard stock market times?

That all depends on how we measure time frames and what we consider protection, but from the look of it, we put much too high of a value on the tangibility of gold.

Let’s take a look at the overall cumulative return chart of S&P GSCI Gold, VIX, S&P GSCI and S&P 500.  Gold looks pretty attractive relative to VIX but we need to dig deeper to see which does a better job as a safe-haven.

Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.
Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.

Using monthly data in the time period from Jan 1990, the only negative years for the S&P 500 were 2000, 2001, 2002 and 2008.  The results of protection are mixed. In 2000 and 2008, VIX returned higher than the S&P GSCI Gold, but the opposite was true in 2001 and 2002.

Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.
Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.

However, the results become more clear when evaluating other metrics. VIX has the lowest correlation to the S&P 500 of -0.63, compared to -0.01 of S&P GSCI Gold with the S&P 500 and 0.18 of the S&P GSCI with the S&P 500.  This implies VIX has stronger diversification properties that could potentially lead to greater capital preservation when mixed with stocks.

Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.
Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.

Further, on average of 287 months measured, 103 months were negative for the S&P 500 and 27 of those lost more than 5% in the month. While gold protected, VIX seems to have done a better job. An average monthly loss for the S&P 500 was 3.6% with a 15% gain from VIX and only 56 basis points from gold.

Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.
Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.

VIX also has the best record of positive months when the S&P 500 lost. In 79% of down months for the S&P 500, VIX was positive.  The S&P GSCI Gold and S&P GSCI didn’t do a bad job but came up short again versus VIX.

Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.
Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.

Finally, maybe when it counts most, we measure two crisis periods during this time: the tech bubble burst and the global financial crisis.  Once again both gold and VIX protect but VIX wins.

Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.
Source: S&P Dow Jones Indices. Data from Jan 1990 to Feb 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.

As investors, and humans, we really might price the value of the golden touch too highly.

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

Recent Interview: Commodities To Upstage Stocks

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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I thought you might be interested in a recent article, Gunzberg: Commodities To Upstage Stocks, written by Cinthia Murphy on March 11, 2014 on etf.com. Many of the discussion points cover the concepts from one of my prior posts, COMMODITY COMEBACK.
 

Commodities markets have been major underdogs relative to record-breaking U.S. equities for much of the past six years. But the tides are now turning, S&P Dow Jones Indices’s global head of commodities Jodie Gunzberg says.

Amid supply shocks around the globe, tapering of quantitative easing in the U.S. and a rising-interest-rate outlook, commodities from corn to hogs to oil seem bound to shine in 2014, leaving equities in their shadows, Gunzberg told ETF.com in a recent interview.

ETF.com: You believe commodities will outperform equities this year as the commodity/equity cycle switches over in favor of commodities. Why?

Jodie Gunzberg: Commodities and stocks have had a long relationship of switching off performance because of the underlying cycle of what’s happening in the companies and the goods that they produce. Equities are forward-looking, and now they’ve been ahead of commodities for six years straight. That’s the second-longest stretch of outperformance over commodities since 1980 to 1987.

What happens is that once companies start doing well, and they’re raising capital, and equities are performing well, they then have the resources to spend on commodities to make more products.

That might be where we’re at now, with companies buying more and more commodities to produce their goods. Through … to read the rest of the interview, please click here.

 

 

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

A Bang not a Whimper

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Whenever this bull market ends, it is likely to be with a bang, not a whimper. The bull market began on March 9th, 2009, five years ago.  The last bull market lasted exactly five years from October 2002 to October 2007; the one before that – the great tech boom – lasted 10 years. This bull market isn’t that old. Aside from the passage of time, the next concern people raise is valuation – are stock prices “too high?”  While valuations, measured by price-earnings ratios, are above long run averages, they are modest or almost reasonable compared to the technology boom of the 1990s. Moreover, the S&P 500 is not concentrated in a few stocks or one sector. Technology is closer to a fifth of the index value today than the third it was at the end of the 1990s. The index itself is not that concentrated either: the largest stock is less than 3% of the total market value.

In keeping with the title, guessing the end of the bear market probably means guessing the next economic, political or financial upheaval.  The situation in the Ukraine is not likely to end the bull market unless the US becomes involved in military action – an extremely remote possibility.  A more likely scenario that might send the market lower would be large default of one or more junk bond issues.  The long period of low interest rates has made people more adventurous with credit risk.  Equity investors, especially after the bear markets in 2002 and 2007, should recognize that stocks can nose dive; bond investors would need memories extending back to the 1970s to understand some of the dangers.  We seem to be nervously safe for the moment.

The charts show how the S&P 500, the Dow and the tech sector in the 500 have developed since 1993. The blue line is the index; the red is the PE ratio.

Source: S&P Dow Jones Indices and Blooomberg
Source: S&P Dow Jones Indices and Blooomberg

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

Some Inconvenient Truths

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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Today’s Wall Street Journal brought the latest in a string of articles suggesting that we have entered a period of particular opportunity for active investment management — a so-called “stock-picker’s market.”  Because the average correlation of stocks within the S&P 500 or other major indices has declined, it’s argued, “active managers are going to do better” as the “cream rises to the top.”

Or maybe not.  The argument in favor of active management in 2014 has to contend with at least three inconvenient truths.

First, the average cannot be above average.  If all asset owners own all the assets there are to be owned, the average asset owner will earn the return of the average asset (i.e., the market return).  If we array the asset owners in rows and the assets they own in columns, the sum of the rows must equal the sum of the columns, and the sum of the changes in the rows must equal the sum of the changes in the columns — so the average return across the rows equals the average return down the columns.  William Sharpe called this “The Arithmetic of Active Management” more than 20 years ago, and the laws of arithmetic still hold.

Of course, there can still be periods when the average institutional manager outperforms a market index — but they occur only when the rows and the columns don’t match.  For example, if individual investors control 80% of the assets, and institutions control 20%, it’s entirely possible for most of the institutions to do better than the market average.  (This may be a fair description of the 1950s and 1960s.)  If a market index doesn’t describe the managers’ entire opportunity set, it’s also possible for the average manager to outperform — perhaps by buying small- and mid-cap stocks while being compared to a large-cap benchmark.

But if the index is sufficiently comprehensive, and the census of all investors is sufficiently accurate — the inexorable arithmetic of active management will hold.  Empirical studies have amply verified the theoretical argument.

Second, correlation is primarily a measure of timing, not of investment opportunity.  Assets which are positively correlated go up and down at the same time; negatively correlated assets move in opposite directions.  It’s not hard to put together an example of two stocks with perfectly negative correlation but with identical returns over the course of a month.  An omniscient day trader would benefit from trading these stocks.  For the rest of us, the benefits are less clear.  The fact that correlations declined in 2013 means that (other things equal) the market will be less volatile in 2014.  It does not mean that active manager performance will improve — the average is still average.

Finally, dispersion — which is a measure of investment opportunity — remains low. Unlike correlation, which measures whether assets go up and down at the same time, dispersion reflects the degree of difference between the best and the worst performers.  In a high dispersion environment, there’s a large gap between the “best” stocks and the “worst” stocks; when dispersion is low, the gap is small.  In 2013, dispersion in the U.S. market — despite falling correlations — was at its all-time low:

Ave monthly dispersion S&P 500Although dispersion ticked up modestly at the beginning of 2014, it’s still well below its historical average level.  This doesn’t mean that a skillful (or lucky) manager will be less skillful (or lucky) than he would otherwise be.  Dispersion says nothing about the level of a manager’s skill, but it signifies something important about the value of that manager’s skill.  The fact that today’s dispersion levels are quite low implies that the rewards to successful stock picking are likely to be small by historical standards.

Which does not sound like a “stock-picker’s market” to me.

 

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