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Where Are the PIGS Now, Minus the G?

Impact of GICS Changes to Pan Asian Sectors: BAT Moving Away From Information Technology

The S&P 500 Bond Index and… Mexico!

Quality and Diversification within the Preferred Stock Space

S&P 500 Posts Best January Since 1997

Where Are the PIGS Now, Minus the G?

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Heather Mcardle

Director, Fixed Income Indices

S&P Dow Jones Indices

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Over the past five years, the more worrisome government-issued debt in Europe has made significant progress in managing the normal mechanism of higher-perceived risk equaling higher yields. The Wall Street Journal focused on Portugal’s debt in their article, “Decade of Easy Cash Turns Bond Market Upside Down”. Quantitative easing (QE) by the European Central Bank (ECB) not only lowered rates to spur economic development in the region, but it also seems to have eased concerns about the risks of buying from some of the heaviest debt-ridden European countries. The negative yield environment created by the ECB’s QE program pushed investors to find higher yields in countries with higher risk profiles. Portugal, Italy, and Spain have all seen yields tighten significantly over the past five years, as measured by the S&P Portugal Sovereign Bond Index, the S&P Italy Sovereign Bond Index, and the S&P Spain Sovereign Bond Index, respectively. As of Jan. 31, 2018, yields for the overall indices saw both Portugal and Spain below 1%, with Italy hovering above 1% at 1.12%. Yields for all three indices have tightened from a range of 3.28%-5% back in the beginning of 2013 to a range of 0.79%-1.12%. When compared to the yield of U.S. Treasuries (2.36%), as measured by the S&P U.S. Treasury Bond Index, one may wonder what the reaction will be when the ECB reverses QE. While all four countries have different durations between 5.24 and 6.47, the U.S. has the shortest duration of them all, with the lowest risk profile and the highest yield.

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

Impact of GICS Changes to Pan Asian Sectors: BAT Moving Away From Information Technology

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Utkarsh Agrawal

Associate Director, Global Research & Design

S&P Dow Jones Indices

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In November 2017, S&P Dow Jones Indices and MSCI announced revisions to the GICS® structure to be implemented in September 2018.[1] These changes are going to affect the consumer discretionary, information technology, and telecommunication services sectors. As a consequence, the Pan Asian internet giants BAT (Baidu, Alibaba, and Tencent) will be reclassified into the communication services and consumer discretionary sectors.

The key GICS structure changes are summarized as follows.

  1. The telecommunication services sector will be broadened and renamed to communication services. The renamed sector will include the existing telecommunications services companies with the addition of media and entertainment companies, which are currently classified under the consumer discretionary sector and information technology sector.
  2. The internet & direct marketing retail sub-industry under the consumer discretionary sector will include companies providing online marketplaces for consumer products and services. It will also include e-commerce companies.
  3. The internet software & services industry under the information technology sector will be discontinued and moved to a new sub-industry, internet services & infrastructure, under the IT services industry.

These changes could result in a significant impact on the composition, valuation, and performance characteristics of the sector indices. Based on the select list of large-cap companies with new GICS information released in January 2018,[2] we compiled the sector weights, return beta, and P/E of the three GICS sectors for the S&P Pan Asia LargeCap Index with the new GICS definitions (see Exhibits 1 and 2). The key observations include the following.

  1. The communication services sector will become less defensive and have more expensive P/E versus the current telecommunication services sector, mainly due to the addition of entertainment companies (such as Nintendo) and interactive media & services companies (such as Tencent). The regional sector weight increases from 4.5% to 10.4%.
  2. After the change in definition of the internet & direct marketing retail industry, the consumer discretionary sector will have higher beta and valuation, with the inclusion of Alibaba, which is currently classified as an internet software & services company. The regional weight of this sector changes from 12.2% to 14.3%.
  3. The information technology sector will have lower beta and P/E in comparison to the current GICS definition, primarily driven by the exclusion of the internet giants BAT, which represent 31.5% of the regional sector under the current classification.

Overall, 17 companies from the S&P Pan Asia LargeCap Index will be affected by the revision to the GICS structure, according to the list announced by S&P Dow Jones Indices and MSCI in January (see Exhibit 3).

Apparently, the revisions to the GICS structure will result in significant change to the risk/return profile and fundamental characteristics of the consumer discretionary, information technology, and communication services sectors. Market participants should be mindful about these changes when evaluating these sectors in their asset allocation or investment analysis.

[1]   For more details, please see https://spindices.com/documents/index-policies/20171115-gics-2018-revisions.pdf

[2]   For more details, please see https://www.spice-indices.com/idpfiles/spice-assets/resources/public/documents/646149_gicspressreleasejan2018.pdf

[3]  Note that the new company classifications are subject to change before implementation due to ongoing reviews, including for corporate events. For more details please see https://spindices.com/documents/index-policies/gics-changes-announcement-01-10-18.xlsx.

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

The S&P 500 Bond Index and… Mexico!

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Jaime Merino

Director, Asset Owners Channel

S&P Dow Jones Indices

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When we talk about investments in the U. S., the first thing that comes to mind is the S&P 500®, since it is used to analyze and track large-cap stocks in the U.S. market. Following this iconic index, in July 2015 S&P DJI introduced the S&P 500 Bond Index, which is designed to be a corporate-bond counterpart to the S&P 500. Market value-weighted, the index seeks to measure the performance of U.S. corporate debt issued by constituents of the S&P 500. One of the uses of the S&P 500 Bond Index is to compare the equity and bond markets—some of these comparisons may include performance and sectors. Taking into account sectors, ratings, and maturities, the index has more than 150 subindices, and is calculated in several currencies. Can the index also be used to compare with indices outside of the U.S.? Let’s compare the performance and returns between the S&P 500 Bond Index and the S&P 500 Bond Index (MXN [returns expressed in Mexican pesos]), with four different Mexican indices, two sovereign bond indices and two corporate bond indices.

Exhibit 1 shows the performance over the past 10 years of the S&P 500 Bond Index, S&P/BMV Mexico Sovereign Bond Index (which tracks nominal fixed-rate bonds and bills), and the S&P/BMV Corporate Bond Index (which is designed to measure the performance of Mexican corporate-issued bonds). Then, in Exhibit 2, we can see the performance differences between the S&P 500 Bond Index (MXN), S&P/BMV Sovereign International UMS Bond Index, and the S&P/BMV Corporate Eurobonos Bond Index, both of which include the returns of the currency, since they track the eurobond market (bonds issued outside of Mexico in U.S. dollars), expressed in Mexican pesos.

With a yield-to-maturity average spread of more than 335 bps for the past three years, it is interesting how the first group behaved similarly (without taking into account the credit crisis in 2007-2008). The second group’s behavior was expected due to the currency; the correlations are shown in Exhibit 3.

Exhibit 4 shows the annual returns in different time frames, where we can see in more detail how similarly the corporate bond markets have behaved for issuers from the U.S. and Mexico—as measured by the S&P 500 Bond Index (MXN) and S&P/BMV Corporate Eurobonos Bond Index, respectively—with three-year returns of 16.00% and 16.56%, respectively, and five-year returns of 15.68% and 15.62%, respectively.

In times of volatility and when searching for yield, Mexico may provide a good portfolio diversification with the extra yield for those seeking it given the correlation between Mexico and U.S. corporate bonds, as well as with their 2017 performance.

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

Quality and Diversification within the Preferred Stock Space

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Derek Babb

Senior Portfolio Manager

Elkhorn Capital Group, LLC

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Preferred stocks are a class of stock that pays dividends at a specified rate and has a preference over common stock in the payment of dividends and the liquidation of assets. This asset class offers investors a unique place in the capital structure that is often overlooked. In addition, their relatively low correlations with traditional asset classes, such as common stocks and bonds, may provide potential portfolio-diversification and risk reduction benefits.

Credit Quality is Often Overlooked

While many investors are attracted to preferred stocks due to their high yields, credit quality can often be an overlooked aspect of a preferred portfolio. A broad preferred index, such as the S&P U.S. Preferred Stock Index, can leave investors overweight junk-rated preferred issues. Adding a high quality, 100% investment grade, sleeve such as the S&P U.S. High Quality Preferred Stock Index, into a preferred portfolio can improve portfolio credit quality which may mitigate the impact of a market sell off.

Sector Composition Matters

Given their market capitalization weighted structure, most broad preferred stock indices are significantly weighted towards the Financial sector. At the end of 2017, the S&P U.S. Preferred Stock index had a 73.2% allocation to Financials, followed by Real Estate at 12.0% and Health Care at 3.5%. The S&P U.S. High Quality Preferred Stock Index exhibited more diversity in its composition, as it finished 2017 with a 59.4% weight to Financials, followed by Real Estate at 18.1% and Utilities at 12.1%.

By adding exposure to the S&P U.S. High Quality Preferred Stock Index, investors may not only benefit from increased credit quality, but will also further diversify their sector and industry exposure.

As of December 29th, 2017, the S&P U.S. High Quality Preferred Stock Index exhibited an indicative yield of 5.09%. At the same time, the indicative yield of the S&P U.S. Preferred Stock Index was 6.11%. While the difference in yield between the two indices is over 1%, what investors are losing in yield, they are gaining in increased credit quality and diversification in the S&P U.S. High Quality Preferred Stock Index.

Jason Giordano, Director of Fixed Income Indices at S&P Dow Jones Indices, states in Fixed Income 101: U.S. Preferred Stock, that preferred stock is an effective portfolio construction tool given its low correlation to both common stocks and fixed income. He notes that an allocation to preferred securities may provide an opportunity for enhanced total returns while potentially reducing overall volatility. Before allocating, however, investors should consider the allocation impact to overall portfolio credit quality and sector diversification.

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

S&P 500 Posts Best January Since 1997

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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If the glass can be more than half full, this stock market glass is so full, it’s time to wonder when it may spill over.  Large-caps continue to lead the U.S. equity market with the S&P 500 (TR)  delivering its 15th consecutively positive month, its best month since March 2016, its best January since 1997 and its eighth best January on record, gaining 5.7% (since 1971.)

Source: S&P Dow Jones Indices

In prior years with January gains this big, all the years ended highly positive with the exception of 1987, which arguably had a structurally different market than today.  While 1995 was the best year on record with a gain of 37.6%, its January that gained 2.6% was not quite as strong as in 2018.  However, the 2nd, 3rd and 4th best years are all on the list with other very high ranking years too.

Source: S&P Dow Jones Indices

The market is excited to say the least.  In a measure of optimism by the outperformance of the S&P 500 versus the S&P 500 Bond Index, the stocks are outperforming by the most, 6.6%, since October 2015, when the outperformance was 7.9%. Also, the consumer discretionary sector showed its greatest optimism with a premium of 10.1%, the 7th most in history, and the most since Sep. 2010, when its premium was 10.5%.  This is supported by the tax cuts and the increased consumer confidence of 125.4 (1985=100), up from 123.1 in December, as reported by the Conference Board.  Though the glass looked more than half full for the health care sector in January that posted its biggest premium since January 2013, that glass may be starting to empty from the push to cut health care costs.  It may not be the only sector starting to look half empty as real estate and utilities are both measuring discounts for the second consecutive month.  Though a few of these glasses are looking half empty most seem still very full. If the S&P 500 Bond Index starts outperforming its more famous stock counterpart, the S&P 500, it could be a warning sign.  Immediately following that high premium in October 2015, the stock market topped on Nov. 3, 2015, and by December investors saw the glass as half empty. The exuberant premium turned into a discount, and in the following period through Feb. 11, 2016, the market dropped 12.7%. 

Source: S&P Dow Jones Indices

In other segments of the U.S. equity market, the performance continued to be strong in January.  The S&P SmallCap 600 (TR) returned 2.5% and the S&P MidCap 400 (TR) gained 2.9%. While consumer discretionary led large caps, gaining 9.3%, its best month since Oct. 2011, health care led small-caps, gaining 11.1%, the most since Sep. 2010, and mid-caps, gaining 8.5%, its best month since Jan. 2012.  The large cap consumer discretionary sector may not be only benefiting from the tax cuts and high consumer confidence but from the international business boost from the weaker dollar.  In the health care sector, where so much business is domestic for smaller and mid cap companies the tax cuts may mean more for them, helping them outperform the larger part of their sectors.  Together with health care and consumer discretionary, financials, industrials, information technology and materials gained regardless of size.  Smaller consumer staple companies have been challenged with changing consumer tastes for food with higher demand for whole and raw ingredients. Mid-cap energy companies also underperformed the big and small parts of the sector as they may not have been able to benefit as much from international business as the large caps but may have also been more hedged and less nimble than small caps as oil rebounded and the dollar fell. Real estate and utilities are suffering from falling bond prices and rising yields from more inflation fears after the passage of the tax cuts.  Large-caps are outperforming mid-caps by 2.9%, the most since Sep. 2014 and are outperforming small caps by 3.2%, the most since May 2017.

Source: S&P Dow Jones Indices

The weaker dollar seems to be winning over the tax cuts in lifting large caps beyond the mid and small size companies, though on average the falling dollar helps mid-caps most. Energy and materials gain most from a falling dollar since the natural resources are priced in dollars.  Although large-caps do most international business, the falling dollar may present growth opportunities for mid-caps that otherwise might not do as much international business.  If the dollar continues to fall, energy, materials, information technology, industrials and consumer discretionary may be where to overweight, as well as in mid-caps and growth.

Source: S&P Dow Jones Indices and Bloomberg DXY

 

 

 

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