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A Bit of Long History

Big Things Come In Small Packages - Part 3

Feliz Año Nuevo From Latin America

Are you celebrating 101010101010?

Hey, Dow Industrials. I have other work to do, ya know.

A Bit of Long History

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Houses or Stocks

Either could be an investment, if only we knew which would perform better?  We don’t, but a recently released academic paper, “The Rate of Return on Everything, 1870-2015” offers understanding and some unexpected facts from the past.  The paper covers 16 developed markets and compiles the real and nominal returns on equities, houses, bonds and short term bills or money market instruments. With a few exceptions, the data run from 1870 to 2015.

Across the entire sample – 16 countries and 100+ years, houses returned 7.05% annually after inflation, edging out equities which gave 6.89%. Moreover, volatility of houses was half of equities: 9.98% vs. 21.94%.  Stocks pushed ahead in more recent years; in the period since 1950, stocks returned 8.28% with volatility of 24.20% compared to houses returning 7.44% with volatility at 8.88%.  Of course, no one owns 16 houses, one in each country.  In the US across the whole history houses returned 6.03% while equities returned 8.39%, a 233 basis point margin. Since 1950 equities widened the margin to 313 basis points: houses returned 5.62% and stocks 8.75%. The spread was even wider from 1980 to 2015.  Houses appear to be better inflation hedges than stocks. However, this shouldn’t be an either-or-choice. The correlation between houses and equities is modest. Moreover, while equities over time appear to be becoming more correlated across countries, houses are not.

The data on the return from owning a house includes both the price appreciation and the imputed rent that accrues to the home owner. When ones owns and lives in a house, she benefits by not paying rent to a landlord – the savings is rent she pays to herself and is part of the return of owning a home much like a dividend is part of the return to owning a stock.

The Risk Premium

The paper reports the risk premium as the return on stocks and houses less the return on bills and bonds. As shown below, the risk premium for the US and for the combined 16 countries is consistently positive and usually large.

The low risk premium in the most recent period (right-most column) is due to the high interest rates prevailing for most of the last 35 years. Close to zero or negative real interest rates came with Quantitative Easing in the aftermath of the financial crisis. In the 1980s and 1990s interest rates were substantially higher than today. The risky returns in the US were higher in the recent period than over the entire period or the 1950-1980 time-frame.  The same pattern is seen among the other nations included in the data.  The charts below show nominal and real short and long rates in the US from 1870 to 2013. These data are from a data set compiled by the authors of the paper.  This confirms the implication of the risk premiums – the high rates of the 1980-2015 period were the anomaly, not the low rates (or negative real) rates that dominate most of the last 145 years.

Citations:

Oscar Jorda, Katherine Knoll, Dmitry Kuvshinov, Moritz Schularisk and Alan M. Taylor, “The Rate of Return on Everything 1870-2015”, National Bureau of Economic Research, December 2017

Data used for charts: Òscar Jordà, Moritz Schularick, and Alan M. Taylor. 2017. “Macrofinancial History and the New Business Cycle Facts.” in NBER Macroeconomics Annual 2016, volume 31, edited by Martin Eichenbaum and Jonathan A. Parker. Chicago: University of Chicago Press.

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

Big Things Come In Small Packages - Part 3

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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If you found a small-cap fund with a 23 year track-record that performed in the top 10th percentile of its peers over a 3-, 5-, 10-, and 15-year period, might you consider investing?  How about if you found out it was also a fraction of the price of its peer group?  Sounds pretty attractive, but unfortunately, there isn’t really “a fund” like this.

However, there is an index called the S&P SmallCap 600 that has performance like this, and it is possible to replicate it.   In fact some managers already do replicate it, and with far lower fees than the average small-cap mutual fund. The industry average fee for a small-cap mutual fund is 1.37%, but there are ETFs that offer products tracking the S&P SmallCap 600 with expense ratios as low as 0.07%.  (Here is a more complete list of S&P SmallCap 600 linked products from our website.)

This is the 3rd part of our blog series containing excerpts from our new paper where we discuss the outperformance of the S&P SmallCap 600 versus the Russell 2000, the performance of the indices compared with active managers, and the case supporting the performance.

SMALL-CAP INDEX PERFORMANCE VERSUS THE ACTIVE SMALL-CAP PEER GROUP
As mentioned in the introduction, the SPIVA U.S. Mid-Year 2017 Scorecard shows the S&P SmallCap 600 outperformed 93.8% of all small-cap funds over a five-year period. Moreover, the report calculates that over the 1-, 3-, 5-, 10-, and 15-year periods, the S&P SmallCap 600 beat 59.6%, 88.7%, 93.8%, 94.1%, and 94.4% of small-cap mutual funds in the University of Chicago CRSP database, respectively. This challenge in beating the index may contribute to why only 3% of funds are benchmarked to the S&P SmallCap 600.

To investigate the performance of small-cap benchmarks relative to institutional active managers, we utilized data from eVestment Alliance. In Exhibits 6-8, we compared the S&P SmallCap 600 and Russell 2000 with two S&P DJI small-cap factor indices that have exhibited strong relative performance over the past 20 years. The S&P SmallCap 600 Low Volatility Index is designed to measure the 120 stocks within the S&P SmallCap 600 with the lowest historical volatility, as measured by the standard deviation of daily price returns over the past 252 trading days. The S&P SmallCap 600 Quality Index is designed to measure the 120 stocks within the S&P SmallCap 600 that have the highest average z-score, which is based on three quality metrics: return on equity (ROE), balance sheet accruals ratio, and financial leverage ratio.

As shown in Exhibit 6, the S&P SmallCap 600 outperformed the Russell 2000 in all periods studied, ranging from one year to the entire period since the inception of the S&P SmallCap 600. The S&P SmallCap 600 also outperformed the median small-cap fund in the 1-, 3-, 5-, and 10-year periods ending Sept. 30, 2017.

Source: eVestment Alliance. Data from April 30, 1995 to Sept. 30, 2017. Chart and table are provided for illustrative purposes reflect hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with back-tested performance.

Exhibit 7 compares the returns of the S&P SmallCap 600 and Russell 2000 to the eVestment U.S. small-cap equity universe from 2007-2016. The S&P SmallCap 600 ranked higher than the Russell 2000 in seven years and tied in one year. Only in 2009 and 2010 did the Russell 2000 rank higher, with a 74th percentile ranking versus a 79th percentile ranking for the S&P SmallCap 600 in 2009, and a 59th versus 62nd percentile ranking in 2010.  In 2014, 2015, and 2016, the S&P SmallCap 600 ranked even higher, in the 45th, 41st, and 24th percentiles, respectively.

Source: eVestment Alliance. Data from Dec. 31, 2006, to Dec. 31, 2016. Chart and table are provided for illustrative purposes reflect hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with back-tested performance

The three-year rolling periods are shown in Exhibit 8. There were a total of eight three-year periods, and the S&P SmallCap 600 ranked higher than the Russell 2000 over every period. The S&P SmallCap 600 was also competitive with the active manager universe, scoring in the top half in five of eight three-year periods.

Source: eVestment Alliance. Data from Sept. 30, 2007, to Sept. 30, 2017. Chart and table are provided for illustrative purposes reflect hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with back-tested performance.

The evidence of the S&P SmallCap 600’s outperformance over the Russell 2000 is clear, not just in plain comparison but juxtaposed to active managers. Conceivably, the S&P SmallCap 600 could be considered not just as a benchmark replacement, but rather it could more widely serve as the underlying index for investable passive funds.

We will explore the reasoning behind results this strong and steady in the next part of this blog series.

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

Feliz Año Nuevo From Latin America

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Jaime Merino

Director, Asset Owners Channel

S&P Dow Jones Indices

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After Donald Trump became the 45th president of the U.S., the Dow® hit the 20,000 mark for the first time in history, there was a total solar eclipse, along with massive hurricanes, floods in Colombia, earthquakes in Mexico, a referendum in Catalonia, and the New England Patriots made an historic comeback in Super Bowl LI, the Houston Astros won their first World Series, and Star Wars Episode VIII opened in movie theaters. Meanwhile, we can take a look how inflation, the reference rate, and currencies from Brazil, Chile, Colombia, Mexico, and Peru moved over the past year and how the sovereign indices of these countries performed.

First, we will take a look at the reference rate from the countries’ respective central banks. The big winners from 2017, in terms of number of movements over the past year, were Brazil and Colombia, which changed their reference rate eight times. Brazil moved it down 600 bps, from 13.75% to 7%, and Colombia moved it in the same direction, from 7.5% to 4.75%. Mexico was the only country (from the observed) that moved the overnight rate on the upside year-over-year, with five changes amounting to an increase of 150 bps, as it closed at 7.25%. Chile and Peru moved theirs -75 bps and -100 bps, respectively. Exhibit 1 shows the reference rates over the year.

In terms of currencies, Chile had the greatest appreciation of the year with 8.16%, followed by Mexico with 5.15%, and Peru with 3.52%. Colombia stayed almost the same, with an appreciation only of 0.65%, and the only currency that depreciated was the Brazilian real, down 1.81%.

As for inflation, Peru hit its lowest inflation level in 10 years when the year-over-year CPI for November came at 1.54%. Inflation in Brazil and Chile was on target (as set by their central banks), with 2.77% and 1.91%, respectively through November. Colombia closed November with 4.12%, while Mexico ended with 6.63%, beyond the ~2% target inflation set by Banxico. Exhibit 2 shows how inflation moved in 2017.

Taking a look at the sovereign indices of the nominal and real rate bonds, the big winner in terms of index performance was Peru. The S&P Peru Sovereign Bond Index closed the year with a gain of 16.98% and the S&P Peru Sovereign Inflation-Linked Bond Index increased 13.02%. On the nominal side, Peru was followed by Colombia and Mexico with gains of 9.02% and 6.59%, respectively. As for the inflation indices, Brazil was second with 12.23%, while Chile was the only country with negative returns for 2017, with -1.47%. Exhibit 3 shows the YTD and quarterly performance of the indices.

I can assure one thing that all Latin America will be expecting this year… and that’s the World Cup!

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

Are you celebrating 101010101010?

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Tim Edwards

Managing Director, Index Investment Strategy

S&P Dow Jones Indices

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News that the Dow broke through 25,000 yesterday was not universally celebrated.  A market index achieved a specific numerical barrier — so what?  The importance of such events is at best anecdotal, and their celebration in the media is increasingly regarded as humbug.  Is there any truth – one might ask – to the theory that such events are “psychologically important”?  That is to say, do they change the behavior of market participants?

Certainly, some numerical values are of demonstrable psychological importance to humans undertaking economic transactions.  Otherwise, supermarket items priced at 4.99 instead of 5.00 monetary units would not sell disproportionately better.

Beyond the average supermarket shopper, or even the most cynical of market participants, nearly everyone has celebrated an anniversary or set a round number goal as an ambition.  To an independent observer, changes in behavior based on the achievement of arbitrary numerical values would seem a most human trait.   So it is logical to expect buyers or sellers whose motivating impulse was the price reaching a particular number to have some impact on capital flows, and therefore the markets.

However, even though investment flows are (for the time being) largely dominated by the decisions of humans, investing has become increasingly professionalized – and, increasingly, non-human.   Do so-called “psychologically important barriers” still exist in any real sense for market indices?  And even if they do, is there anything important about the Dow passing 25,000?

I suspect the impact of such occasions may be less material today than when markets were less professionalized.  Or, perhaps the particular barriers that are considered important will change.  The S&P 500 index today passed above the level of 2730 for the first time, which doesn’t sound very interesting to the average human, but in binary that means it has passed 101010101010.  Perhaps some computers are celebrating this fact as I write, perhaps – now that you know – you will, too.

 

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

Hey, Dow Industrials. I have other work to do, ya know.

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Jamie Farmer

Chief Commercial Officer

S&P Dow Jones Indices

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Yet here I am, writing about the DJIA crossing through yet another 1,000 point milestone – 25,000, no less – a mere 23 trading days after the last one and right on the tail of the 5 successive 1000 point marks achieved last year.

With the 152.45 points (0.61%) gained during today’s session, the Dow closes at 25,075.13 and is up:

  • 1.44% year-to-date (over all of 3 trading days)
  • 27.08% since Trump’s inauguration (I’ll leave to others on where to ascribe credit)
  • 283.00% since the Financial Crisis low of 6,547.05 hit on March 9, 2009
  • 77.03% since the pre-Financial Crisis high of 14,164.53 hit on October 9, 2007

As for elapsed time, this 23 day sprint from 24k to 25k is – by a single day – the fastest the DJIA has ever covered that ground; the moves from 10-11k and 20-21k each took 24 days.  The returns for each climb, however, are markedly different:  10-11k represented a 10.1% return, for example, while the most recent mark is just a 3.31% increase.

And what are the drivers?  Following are top 5 point contributors to each of the most recent milestones as well as the march from 15k to 25k (which transpired from May 2013 to the present).  Boeing (BA) is the clear standout recently having contributed 17.7% of the run from 20-25k; as for the climb from 15-25k, Boeing was again the top stock followed by UnitedHealth Group (UNH) and 3M (MMM).

Again, when discussing this topic the standard caveats apply:  a) though the aggregate DJIA advance is certainly notable, each 1,000 point mark is, while an interesting emotional milestone, an otherwise arbitrary threshold, and b) as noted above, each new mark represents a smaller percentage gain than its antecedents.

By the way, if you’re looking for a “Dow 25,000” hat to add to your collection, don’t come to me.  At this rate, I don’t have the personal budget to keep printing them.

* – Don’t be confused as to how a 1,000 point milestone can be covered with 800 or 900 points.  Remember that for this exercise, we’re striking from the closing DJIA value on the day each milestone was crossed and these never land right on the even thousand point mark.  In the most recent case (24-25k), for example, the move was from 24,272.35 to 25,075.13 (or 802.77 points).

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