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Ports in the Storm

These Assets Mix With Oil Like Water

Fear of Fear Itself Reaches Crisis Levels

Observations on January Release of S&P Claims Based Indices (Allowed Charge Trends): Part 2

Inside the S&P 500: How Sector Weights Adjust for Oil

Ports in the Storm

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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Since last fall, the S&P 500 has gone through three distinct downdrafts.  Between September 18 and October 15, the index fell by 7.3%.   It recovered that lost ground, and then some, rising

500 18_Sept_14 to 14_Jan_15

11.8% through December 5.  Then a second, less severe, decline began, as the index fell 4.9% between December 5 and December 16, followed by a 6.0% recovery through December 29.  This brought the S&P 500 to its (so far!) all-time high.  From December 29 through yesterday’s close, the index is down an additional 3.7%.  Patterns in the S&P MidCap 400 and S&P SmallCap 600 Indices have been very similar to those in the 500.

The net of these gyrations is a total return of 0.6% in the 82 days since September 18, but with heightened volatility; the standard deviation of daily returns for the S&P 500 was 14.5%.  In the 82 days prior to September 18, the standard deviation of daily returns was only 8.0%.  So we have just come through a period that is relatively directionless but quite choppy; investors who are preoccupied by the chop may not even notice that their total returns are still positive.

One of the notable things about directionless, choppy markets is that defensive strategies tend to do surprisingly well.  The S&P 500 Low Volatility Index, e.g., rose by 8.7% since September 18 — mitigating the three periods of decline, while lagging the S&P 500 during its rebounds.  This pattern of protection in down markets and participation in up markets is typical of low volatility strategies, and seems to occur on a global basis.   The low volatility flavors of the S&P 400 and S&P 600 also provided protection in the recent down periods and participation in the up moves.  It’s not perfect protection, obviously, and it’s not full participation, but the record shows that all three low vol indices performed as we would have expected.

Low vol vs. vanillas

We’re dealing with only four months of data, of course, and past performance is never a guarantee of future results.  And it’s fair to say that low vol strategies have historically lagged in a strong market advance.  But for investors who want equity exposure, would prefer a smoother ride, and are willing to underperform in a strong market — low volatility strategies may offer a comfortable port in the storm.

 

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

These Assets Mix With Oil Like Water

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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While many assets have some relationship with oil, there are varying degrees of correlation and even a few surprises. For example, Canadian equities are more correlated with oil than are the emerging markets and the US equities; Australian equities are barely correlated with oil, and China who is not nearly as big a producer as a consumer is moderately correlated with oil.

Gold and (Brent) oil are not as oppositely related as many think but have a weak-moderately positive correlation of 0.32. (Correlation of +1.0 is perfectly positive, indicating assets move in lockstep, correlation of 0 indicates no relationship, and correlation of -1.0 is perfectly negative, indicating opposite movement. Generally the more negatively correlated the assets, the more diversification.) While gold straddles the line between a low and moderately positively correlated relationship, a few other asset show more diversification historically.

Real estate and bonds show little relationship with oil with correlations of 0.18 (REITs), 0.07 (S&P Case Shiller) but VIX is the one asset with even moderately negative correlation with oil of -0.32.

Oil Correlation

 

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

Fear of Fear Itself Reaches Crisis Levels

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Reid Steadman

Managing Director, Global Head of ESG

S&P Dow Jones Indices

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Franklin Delano Roosevelt would be disappointed. The US fear index, officially named the CBOE Volatility Index (VIX), has ticked up, averaging 16.4 since the beginning of Q4 2014, compared to 13.5 in the first three quarters of last year. If the story stopped there, we might still be able to look FDR in the eye. But we are in an even worse condition. Contrary to his advice, we are fearing “fear itself,” and doing so at levels typical of major crises, including the financial meltdown of 2008.

How do we know we are this anxious? The “VVIX” tells. The VVIX is an index that measures the volatility of VIX – in other words, the volatility of volatility.

I have seen people shake their heads in disbelief that the quants at CBOE would afflict us with an index so perplexing. If you think the same, it’s worth putting your reaction aside and getting to know this index. It says something interesting.

Here’s what you need to know about VVIX:

  1. It uses the same methodology as VIX, but instead of communicating the 30-day implied volatility of the S&P 500, it tells you the 30-day implied volatility of VIX itself.
  2. Instead of using options based on the S&P 500 in its calculation, this index uses VIX-based options.
  3. In terms of performance, VVIX and VIX are not as closely tied as VIX and the S&P 500. VVIX has spiked at different times when VIX has jumped, but when VIX is low, VVIX bounces around more than you would expect.
  4. Like VIX, VVIX is mean reverting, but it reverts to a much higher level. The average for the VVIX since 2007 – the first year when VVIX posted values for every trading day – is 86.1, compared to 21.8 for VIX for the same period.

With all this in mind, let’s take a look at a chart.

vvix

What jumps out is that VVIX in recent weeks and months is significantly up, even as VIX has stayed near its average. Why would this be? My honest answer is that I don’t know, but it could stem from the nature of the issues we are facing.

In many of the past crises, we have encountered challenges that were difficult to resolve but easy to define, in terms of timetable and influencing factors. An example would be the US government debt crisis of 2011. We were caught between two familiar political parties butting heads and creating uncertainty around the US national budget. Though we didn’t know the outcome at the time, the source of the uncertainty and the decision points that would determine what would happen in this crisis were widely known.

The challenges we are facing now are different. The drop in the oil price and the tensions between Russia and Ukraine are open ended – there is no known timetable for resolving these two issues – and they are much more complex in nature. The actions of many governments, companies, and individuals will determine how these crises evolve. To channel Donald Rumsfeld, all of this ambiguity creates worry about “unknown unknowns” and fear of fear itself.

 

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

Observations on January Release of S&P Claims Based Indices (Allowed Charge Trends): Part 2

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John Cookson

Principal, Consulting Actuary

Milliman

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Although the overall medical trend rates covering all services have continued to be modest in the S&P data through the 3rd quarter of 2014[1],  the prescription drug trends have been more volatile but modest prior to mid-2013, but have continued to accelerate since then through September 2014.  On a 3-month basis they have climbed to 11.7% by September (before deductibles, copays, etc.).  Cost pressure on generics and brand drugs (perhaps generated by price concessions on Medicare by the pharma companies) have shown an uptick in the last year, however, the introduction of Sovaldi and other new and expensive drugs in early 2014 (which are now incorporated in our economic forecasts) are further pushing up drug costs.  Furthermore, the impact of deductible/fixed dollar copay leverage can be quite substantial on drug plans and have pushed drug trends to insurers even higher than shown in our forecast worksheet.  The impact of more new and expensive drugs for cancer, cardiovascular and cholesterol in 2015 can be expected to potentially push trends higher than the economic forecasts in our models until it gets completely factored into the data.  Recent anecdotal data seems to indicate that Sovaldi growth may have peaked in the short term, while patients are waiting for the new alternative product Harvoni.  In addition to the high cost of Sovaldi, there are issues about the required additional drugs, and the somewhat higher drug regimen termination rates than in initial trials of the drug that could be causing a slowdown in its prescription rate.  A number of combination drugs for Hepatitis C were expected to become available starting in 2015 that help reduce some of the negative effects mentioned, and some patients may be holding off for these new options.

Capture

 

THE REPORT IS PROVIDED “AS-IS” AND, TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, MILLIMAN DISCLAIMS ALL GUARANTEES AND WARRANTIES, WHETHER EXPRESS, IMPLIED OR STATUTORY, REGARDING THE REPORT, INCLUDING ANY WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE, TITLE, MERCHANTABILITY, AND NON-INFRINGEMENT.
[1] We track the LG/ASO trends as representative of underlying trends, since Individual and Small Group are impacted more significantly by the Affordable Care Act (ACA).  Keep in mind that actual trends experienced by plans are likely to be higher than as reported in S&P data.  Trends experienced by large employers on plans that have not changed in the previous year could be higher by as much as 2% or more on bronze level plans and higher by 1% or more on gold level plans due to the effects of deductible and copay leverage.  So risk takers need to take this into account.  In addition, the S&P Indices do not reflect the impact of benefit buy-downs by employers (i.e., higher deductibles, etc.), since the indices are based on full allowed charges.  As noted above, actual trends experienced by employers and insurers in the absence of benefit buy-downs can be expected to be higher than reported S&P trends due to plan design issues such as deductibles, copays, out-of-pocket maximums, etc.   Benefit buy-downs do not represent trend changes since they are benefit reductions in exchange for premium concessions, but they can have a dampening effect on utilization due to higher member copayments, and this can have a dampening effect on measured S&P trends compared to plans with no benefit changes, further pushing up experienced trends relative to those reported in the indices.

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

Inside the S&P 500: How Sector Weights Adjust for Oil

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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From May 30th 2014 to last Friday, January 9th, the energy sector in the S&P 500 was down 18.1% while the overall index was up 6.3%. As energy under-performs the overall index, its weight within the index is dropping, reducing the impact of further energy weakness on the index.  The energy sector weight is down by more than a fifth, from 10.8% at the end of May to 8.2% last week.

The nature of a market cap weighted index is to adjust to mitigate the damage, or take advantage of, a trend as long as the trend is maintained.  The weight of any stock, or sector, in the index is simply the ratio of its market value to the total market value of the index. If energy stocks drop by one percent today and the rest of the index rises (or falls by less than one percent), the energy sector weight will drop and the weight of the other sectors will rise.  If the energy sector steadily and consistently falls compared to the rest of the market, its weight falls. For an investor holding a portfolio tracking the S&P 500, a one percent loss in energy today is less damaging than a one percent energy loss was last summer. This may sound like almost magical risk management – the more energy under-performs, the smaller the exposure.  There is one caveat: when oil prices bottom out and begin to rise, the exposure to oil and energy will have been minimized. At the exact moment when an investor wishes to be over-weighted in energy, she would be under-weighted.

Those who remember the end of the tech stock boom in March 2000 saw the same process in the other direction. For two or three years, tech stocks led the market up and month by month the tech sector weighting in the S&P 500 climbed from about 15% to a third of the index.  But when techs crashed, the entire market was over-weighted in the wrong direction.

The chart shows the performance of the energy sector of the S&P 500 and the S&P 500 excluding energy as well as the energy sector weight (the shaded region).

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