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Energy Continues its Performance Drag on Bonds in August

OK Jobs Report Gives No Hint for the Fed

What Rising Rates Won’t Do

Large Cap Funds: Active Versus Passive

Rising Dispersion and the Value of Stock Picking

Energy Continues its Performance Drag on Bonds in August

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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Crude oil, as measured by the S&P GSCI All Crude was down 20% in July 2015 and has continued its sell-off in August 2015 by dropping another 6.86%.  As of Aug. 10, 2015, the index has returned -25.4% YTD.  Energy-related bonds in the investment-grade or high-yield indices have added a negative hit to the indices’ overall performance.

The energy sector of the S&P U.S. Issued Investment Grade Corporate Bond Index accounts for 8.6% of the index’s market value.  So far in August 2015, the sector has remained positive, returning 0.14%, almost offsetting July 2015’s -0.15% return.  June 2015 had a more significant negative performance with -2.05%.  The S&P U.S. Issued Investment Grade Corporate Bond Index has returned 0.16% MTD and -0.03% YTD.  The S&P 500® Energy Corporate Bond Index, a sub-index of the S&P 500 Bond Index that includes both investment-grade and high-yield issuers of the equity index, has returned -0.11% MTD and -0.72% YTD.

In the S&P U.S. Issued High Yield Corporate Bond Index, the energy sector has had more of an impact, as the market value weight of the sector is 14.4% of the index.  Already in August 2015, the energy sector is down 2.9%, following a 5.37% loss in July 2015 and a 3.31% loss in June 2015.  At the end of May 2015, the S&P U.S. Issued High Yield Corporate Bond Index had a YTD return as high as 4.08%, but it has returned 1.18% YTD.

Treasury yields, as measured by the S&P/BGCantor Current 10 Year U.S. Treasury Bond Index, moved 17 bps lower in July 2015.  The first week of August 2015 saw the yield-to-worst of the S&P/BGCantor Current 10 Year U.S. Treasury Bond Index close almost flat, after moving 12 bps higher on the release of stronger Factory Orders and ADP Employment numbers.  However, the increase in rates did not last long, as the yield-to-worst moved down 10 bps to close at 2.17%.  The index has returned 0.18% MTD and 1.57% YTD.  Market participants will return from their vacations in August 2015 to focus on September 2015 and the possibility of a Fed rate hike.

Exhibit 1: Index Values
Index Values

 

 

 

 

 

 

 

 

 

Source: S&P Dow Jones Indices LLC.  Data as of Aug. 7, 2015.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

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

OK Jobs Report Gives No Hint for the Fed

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Anyone hoping that this morning’s employment report would send a clear message to the markets and the Fed about the timing of a rate increase was sorely disappointed.  There is virtually no change from last month, even to the second decimal place on some lines. The charts show the unemployment rate — unchanged — and the rise in payrolls — a touch weaker — than in June.  One positive note, average hourly earnings rose 2.4% from July 2014, a bit stronger than last time. (from The Employment Situation Report, 8-7-15.) Click on chart for larger image.

Debate over whether the Fed will, or should, raise the Fed funds target centers around inflation, jobs and GDP.  Taken together these don’t make an clear case for higher interest rates. Unemployment is down, job growth is good but there could still be some slack in the labor markets given the lower participation rate. Inflation is still below the Fed’s target although it is closer than a year ago. GDP growth is not all that impressive.  All these  miss one point: the Fed would like to take real steps towards normal monetary policy and begin shrinking its balance sheet.  With favorable economic conditions, this may be time to move forward.

The odds for a Fed move in September remain a bit better than 50-50.   but we will have to wait for the next employment report on Friday September 4th for a better guess.

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

What Rising Rates Won’t Do

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Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

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Here is a dramatic chart:

what rising rates won't do1

It provides a complete history of the trajectory of interest rates over the last sixty years—and also the backdrop for why there’s so much ado about rates today.  It also explains the consensus sentiment that there is only one direction for interest rates to head. We have no desire to enter the pervasive discourse around the timing and pace of the expected rise in interest rates.   But we can suggest three important things that will not happen when interest rates do rise.

First, rising rates won’t foretell the direction of the stock market, as the next chart illustrates.

what rising rates won't do2

Conventional wisdom is that rising interest rates are bad for equities. But in the last 25 years, the presumed relationship between equity performance and interest rates has been severely challenged.

Second, rising rates won’t foretell whether stock market dispersion will widen.  Dispersion is a measure of the degree to which the components of an index perform similarly.  If the components are tightly bunched, dispersion will be low and, other things equal, active managers will be challenged to add value by stock selection.

what rising rates won't do3

Dispersion rose in July, and may continue to do so.  But as the historical data show, there is no reliable relationship between changes in dispersion and changes in interest rates.

Finally, rising rates won’t foretell the performance of factor indices.  We examined several pairs of nominally opposite factor indices (e.g., growth vs. value, low volatility vs. high beta, etc.).  In no case is there reliable evidence that interest rate changes have an impact on the relative performance of factor indices.   The chart below highlights this for the S&P 500 Low Volatility and High Beta Indices.

what rising rates won't do4

There will no doubt be many economic and market effects attributed to the rise in interest rates, when it comes.  This trifecta serves as a good reminder that analyzing the behavior of the equity market involves more than just the Fed’s decrees.

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

Large Cap Funds: Active Versus Passive

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Todd Rosenbluth

Director of ETF and Mutual Fund Research

S&P Capital IQ Equity Research

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In the first half of 2015, investors pulled $22 billion out of large-cap core U.S. equity mutual funds, but added $19 billion to S&P 500® Index-linked mutual funds. While this confirms that active management is losing share to passive, we think there are still strong active large-cap mutual funds to choose from.

According to S&P Dow Jones Indices, just 23% of all large-cap core active funds outperformed the S&P 500 Index in the three-year period ended 2014. (It is not possible to invest directly in an index, and index returns do not reflect expenses an investor would pay). On an equal-weighted basis, the average large-cap fund’s 18.6% three-year annualized return lagged the S&P 500 index by approximately 180 basis points. These performance challenges are not rare, as just twice in the past ten calendar years more than 50% of actively managed funds have beaten the “500”. A separate S&P Dow Jones study revealed how hard it is for those large-cap funds that outperformed to continue to do so. Indeed, just 4.5% of the outperformers in the 12-month period ended March 2011 maintained their top-half ranking in each of the four subsequent 12-month periods.

The S&P Dow Jones Indices studies highlight that you would be better off with an index-based large-cap offering than choosing an average active fund. In fact there are many below-average performers. For example, Davis New York Venture Fund (NYVTX) is among the biggest large-cap core funds, yet it lagged peers in four of the five last five calendar years. Indeed, NYVTX and its sister share classes had $2.8 billion of outflows in the first half of 2015.

Of course, nobody aims to invest in a below-average mutual fund.

S&P Capital IQ’s mutual fund rankings incorporate holdings-based analysis as well as a review of a fund’s relative track record and cost factors. We find 30 large-cap funds meet our criteria, though some of multiple share classes of the same portfolio.

The list of funds included American Century Equity Growth Fund (BEQGX), Fidelity Fund (FFIDX) and T Rowe Price Growth & Income Fund (PRGIX), Vanguard Growth & Income Fund (VNQPX).

S&P Capital IQ hosted a client webinar on active versus passive strategies on Tuesday, August 4, but you can listen to a replay http://t.co/4KDPwLW9Aj or email wealth@spcapitaliq.com. Reports on the aforementioned mutual funds and ETFs can be found on MarketScope Advisor.

Please follow me @ToddSPCAPIQ to keep up with the latest ETF Trends

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The views and opinions of any contributor not an employee of S&P Dow Jones Indices are his/her own and do not necessarily represent the views or opinions of S&P Dow Jones Indices or any of its affiliates.  Information from third party contributors is presented as provided and has not been edited.  S&P Dow Jones Indices LLC and its affiliates make no representations or warranties of any kind, express or implied, regarding the completeness, accuracy, reliability, suitability or availability of such information, including any products and services described herein, for any purpose.

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

Rising Dispersion and the Value of Stock Picking

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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The U.S. equity market’s dispersion rose substantially in July, ending the month at 7.3%, well above June 30’s 4.5%.  Dispersion for the S&P MidCap 400® and S&P SmallCap 600® likewise rose in July, and the component correlation of all three indices declined.  This is not surprising in a month dominated by individual earnings announcements.  Lower correlation means there’s less tendency for stocks to move together, and higher dispersion means that the gap between the winners and the losers grows — more or less what we’d expect when company, rather than macroeconomic, news is most important.

We’ve long argued that the market’s low dispersion in 2014 was a major contributor to the failure of most active managers to outperform their index benchmarks.  So if dispersion remains high, other things equal, active stock pickers might benefit.  But there are at least three cautions to offer before concluding that the long-sought “stock-picker’s market” has finally arrived.

First, dispersion might not stay high.  July’s upward move is impressive, to be sure, but in January 2015, S&P 500® dispersion rose from 4.2% to 6.7%, a move almost as large as July’s.  Dispersion fell in the next two months, so that by the end of March, it was back to its year-end level.  One month, in other words, does not a high dispersion regime make.

Second, the percentage of active managers who outperform their benchmarks does not depend on the level of dispersion.  Dispersion is a pre-cost measure, so if dispersion rises relative to its 2014 level, more managers may be able to earn enough incremental return to cover their trading and research costs and generate positive alpha for their clients.  But this is a marginal effect.  As our SPIVA research has consistently demonstrated, most active managers underperform most of the time.  If dispersion rises, successful stock pickers will earn more, and unsuccessful stock pickers will lose more.

Finally, rising dispersion will have predictable effects on the performance of some factor indices.  For example, if winners keep winning and losers keep losing, that’s a recipe for increased dispersion.  In such an environment, momentum indices (which buy winners and shun losers) will tend to do well, and equal weight indices (which do the opposite) will tend to underperform.  (In July, in fact, the S&P 500 Momentum Index outperformed its equal weight counterpart.)  Through July 31, the cap-weighted S&P 500 outperformed equal weight (3.35% vs. 1.69%).  Rising dispersion might cause that gap to widen.

An equal weight index measures the return of the average index component.  When equal weight is outperforming cap weight (as it typically does), stock picking is relatively easy — in fact a randomly-chosen portfolio should outperform the cap-weighted index.  When cap weight outperforms, stock picking is much harder.  (Some active managers recoil in horror at the memory of the late 1990s, when the cap-weighted S&P 500 outperformed equal weight for six consecutive years.)  If cap weight continues to outperform equal weight, stock selection will continue to be challenged, regardless of dispersion’s level.

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