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Does the S&P/BMV Mexico Target Risk Index Series Provide Inflation Protection?

I’m Exhausted

Asian Fixed Income: China and the Global Bond Market

As Volatility Returns to Equities, Corporate Bond Spreads Tighten Near Record Lows

Earnings Revision Strategies in Asia

Does the S&P/BMV Mexico Target Risk Index Series Provide Inflation Protection?

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Maria Sanchez

Associate Director, Global Research & Design

S&P Dow Jones Indices

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As of Dec. 31, 2017, the year-over-year change in inflation for Mexico registered at 6.77%, a figure that raised concerns within the pension fund industry.

One of the key risks facing retirees is the erosion of purchasing power of investment returns due to high inflation. Developing economies, such as Mexico, are more susceptible to rising inflation levels than developed nations. In this blog, we examine if traditional retirement indices available in Mexico can provide a degree of inflation protection. With that in mind, we compare the year-over-year change in the inflation level observed in Mexico to the returns of S&P/BMV Mexico Target Risk portfolios that were constructed based on risk tolerance level.

The S&P/BMV Mexico Target Risk Index Series was launched on Nov. 1, 2016. This series comprises four multi-asset-class indices, each corresponding to a particular risk level. These indices are intended to represent stock-bond allocations across a risk spectrum from conservative to aggressive, while considering the investment constraints of local pension funds, as prescribed by the Comisión Nacional del Sistema de Ahorro para el Retiro (CONSAR), the pension system regulator in Mexico.

We used information publicly available on the Instituto Nacional de Estadística y Geografía (INEGI) website for the monthly historical series of the National Consumer Price Index (CPI)[1] from Dec. 31, 2008, which is the first value date of the S&P/BMV Mexico Target Risk Conservative Index, S&P/BMV Mexico Target Risk Moderate Index, S&P/BMV Mexico Target Risk Growth Index, and S&P/BMV Mexico Target Risk Aggressive Index.

Looking at the rolling 12-month returns and monthly year-over-year change in the Mexico CPI (Índice Nacional de Precios al Consumidor—INPC) in Exhibit 1, we note that all the indices had returns higher than the inflation rate, except in 2013. In 2013, the S&P BMV Mexico Target Risk Aggressive Index, posted returns lower than the inflation rate. This is due to the fact that long-term Mexican fixed income was negatively affected by the U.S. Federal Reserve announcement that it would begin reducing its quantitative easing program. Long-term fixed income represents 62% of the total fixed income allocation in the aggressive strategy. It is worth remembering that the aggressive portfolio is oriented toward younger workers with an investment horizon of greater than or equal to 29 years.

Different types of assets have different behaviors against inflation. Target risk strategies have varying degrees of allocation to inflation-linked bonds, nominal bonds, corporate bonds, and local and global equity in order to achieve specific investment outcomes. The goal of the S&P/BMV Mexico Target Risk Conservative Index is capital preservation and its 55% allocation to inflation-linked bonds is a testament to the positive correlation against inflation during the nine-year period (see Exhibit 2). The S&P/BMV Mexico Target Risk Moderate Index, S&P/BMV Mexico Target Risk Growth Index, and S&P/BMV Mexico Target Risk Aggressive Index present slightly lower correlation, implying a similar degree of inflation resistance, on average.

The S&P/BMV Mexico Target Risk Index Series is aligned with the age ranges applicable for each Sociedad de Inversión para las Afores (Siefore) by construction, as described in our paper “Benchmarking Lifecycle Investment Strategies: Introducing the S&P/BMV Mexico Target Risk Indices.” Furthermore, the index series has shown that it can potentially generate returns that are greater than inflation, thereby preserving buying power of retiree income.

[1]   Instituto Nacional de Estadística y Geografía, consultation date: Jan. 9, 2018, 10:32:37. http://www.inegi.org.mx/sistemas/IndicePrecios/Cuadro.aspx?nc=CA55&T=%C3%8Dndices%20de%20Precios%20al%20Consumidor&ST=%C3%8Dndice%20Nacio

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

I’m Exhausted

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Jamie Farmer

Chief Commercial Officer

S&P Dow Jones Indices

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T-G-I-F.  And I would’ve written something sooner about The Dow but the Wi-Fi in my underground bunker, where I retreated for the impending apocalypse, is spotty.  I’ll need to do something about that if this keeps up.

Obviously, that’s a joke.  I don’t have Wi-Fi in my bunker.  But it’s no joke that this has been a volatile couple of days for the U.S. equity markets.  Offered here are a few highlights (lowlights?) from a tumultuous week:

  1. A Weak Week – Closing at 24,190.90, the DJIA lost 5.21% over the last 5 days resulting in the worst weekly performance since the early days of January 2016. Then, a potential Chinese economic slump and crashing oil prices imbued the markets with pessimism.  Ironically, and in contrast, many commentators pointed to good economic news as a leading culprit this time.  As bad as it was, this week could have been worse:  today’s volatile session – down sharply intra-day – eventually rallied for a 330+ point gain.
  2. 1,000 Point Days – Prior to this week, there had never been a single day 1000 point move. Now, there’ve been two.  After a 665 point swoon last Friday, Monday piled on with an historic drop of 1,175.21 points (-4.67%).  Then came Thursday’s fall of 1,032.89 (-4.15%).  Keeping perspective, as repeatedly noted, while 1000 point declines make for frightening headlines, the percentage changes represented by those moves are not uncommon.  To wit, there have been nearly 300 daily 4% or greater moves since the DJIA’s inception.  Put another way, 3 of the top 10 worst point drops on record occurred during this recent spell; none of them, however, come anywhere near the worst percentage drops.

  3. I Can Go In, I Can Go Out – The generally accepted definition of a “correction” is a drop of 10% from recent highs; the DJIA both entered and exited correction mode this week. At Thursday’s close, the Average had fallen 10.36% from the high of 26,616.71 posted on January 26; with today’s rally, the DJIA is currently off 9.11% from that record.
  4. Company Contributions – Alas, the pain was widespread. For the week, every one of the DJIA’s 30 stocks made negative contributions for a total loss of over 1,330 points.  The three biggest detractors were 3M (MMM), Boeing (BA) and UnitedHealth Group (UNH).  Perhaps not surprisingly, these same three names were also the three biggest positive contributors during the Average’s huge run from 20k to 25k.


5. Volatility Spike
– The return of volatility was clearly the most prominent theme this week. Two 1000 point declines plus two days of strong gains plus huge intraday swings throughout the week were evidence of whipsaw trading and increased realized & implied volatility.  How much more volatile?  The trailing 21 day volatility of the DJIA closed out last year at 6.58; today, that same measure is more than 4 times higher at 26.87.

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

Asian Fixed Income: China and the Global Bond Market

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Michele Leung

Director, Fixed Income Indices

S&P Dow Jones Indices

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In a previous piece, we discussed that China’s lackluster performance had made it the worst-performing country in the Pan Asian bond market in 2017, and that it was the only country that closed the year in negative territory. The one-year total return of the S&P China Bond Index fell 0.29% last year (see Exhibit 1), contrasting with the strong gains observed in previous years.

The S&P China Bond Index also underperformed the broad market. The S&P Global Developed Aggregate Ex-Collateralized Bond Index (USD), which seeks to track the performance of investment-grade debt issued by sovereign, quasi-sovereign, foreign government, and corporate entities in developed countries, delivered a total return of 7.64% in 2017.

Specifically for the corporate bond sector, China lagged its U.S. counterpart. The S&P 500® Bond Index is designed to measure the performance of U.S. corporate bonds issued by the constituents of the iconic S&P 500, and it rose 6.05% last year, compared with the 0.58% gain in the S&P China Corporate Bond Index (see Exhibit 2).

In terms of yield performance, the yield-to-worst of the S&P China Bond Index widened 178 bps to 4.78%, as of Dec. 29, 2017. As a comparison, the yield-to-maturity of the S&P Global Developed Aggregate Ex-Collateralized Bond Index (USD) and the S&P 500 Bond Index were 1.41% and 3.28%, respectively.

Despite their performance, China’s solid economic growth, attractive bond yields, and the underparticipation of foreign investors may serve as positive drivers for the Chinese bond market.

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

As Volatility Returns to Equities, Corporate Bond Spreads Tighten Near Record Lows

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Jason Giordano

Director, Fixed Income, Product Management

S&P Dow Jones Indices

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Broad-based equity markets have been on a rollercoaster ride since Jan. 30, 2018, as market participants appear to be reassessing the impact of inflation and potential consequences from the recent tax reform. While volatility appears to be back, high-grade corporate bond spreads have tightened to levels not seen since 2007. Compared with the last episode of substantive volatility in equities, there is a noticeable difference in how credit markets are reacting (see Exhibit 1).

In 2016, equity indices began the year down double digits, as oil prices plummeted and contagion spread, while multiple energy companies filed for bankruptcy. As a result, investment-grade credit spreads widened by 50 bps, with high-yield spreads jumping over 200 bps.

2018’s volatility is showing markedly different results in the bond market. As of Feb. 5, 2018, investment-grade spreads had tightened 6 bps and were more than 110 bps tighter compared with February 2016, as measured by the S&P 500 Investment Grade Corporate Bond Index.

There were several factors contributing to this.

1) Increased U.S. Treasury Yields: Inflationary pressures from global growth, increasing wages, and quantitative tightening have driven yields higher throughout the curve. The yield on the 10-year U.S. Treasury bond (as measured by the S&P U.S. Treasury Bond Current 10-Year Index) rose 30 bps in January and hit 2.70% for the first time since 2014 (see Exhibit 2).

2) Market Technicals: High-grade issuance was relatively sparse in January, specifically in the non-financial space. Total issuance volume was down over 30% compared with January 2017, with non-financials sectors capped at USD 27 billion—a 45% reduction from 2017. Many market participants anticipate that the repatriation and tax changes in the new laws may potentially affect borrowing patterns with high-quality issuers, and that sentiment was reflected in average new issue spreads (see Exhibit 3).

3) Credit Fundamentals: Investors appear comfortable with current corporate credit fundamentals. The bullish argument asserts that the reduction in corporate tax rates will have a front-loaded impact. Since these rates become effective in 2018, many corporations will have an immediate increase in their level of free cash flow. Additionally, changes in the tax code could also allow companies to use repatriated cash to delever, further reducing credit risk.

 

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

Earnings Revision Strategies in Asia

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Utkarsh Agrawal

Associate Director, Global Research & Design

S&P Dow Jones Indices

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Factor-based strategies have been regularly used by market participants in their portfolio construction process. Apart from the established factors like value, size, volatility, etc., research on alternative factors has remained important to explain sources of alpha. One such alternative factor is consensus analysts’ earnings forecasts. Ample empirical research exists that explains the market’s reaction to analysts’ earnings forecasts. Most of the research focuses on the change in the consensus estimate or the number of upgrades or downgrades in the estimates over short-term periods.

Compared with the U.S. and the European markets, the Asian market is more distributed and each individual market in Asia has its own characteristics. In our research paper Do Earnings Revisions Matter in Asia, we tested earnings revision strategies across seven Pan Asian markets—Australia, China, Hong Kong, India, Japan, South Korea, and Taiwan. We examined the three-month change in the consensus estimate and the three-month diffusion of analysts’ earnings forecasts from Dec. 31, 2005, to Dec. 31, 2016.

The key findings were as follows.

  1. Stock prices tended to move in the same direction as their earnings revisions in the majority of Pan Asian markets. Earnings revision strategies delivered the most significant excess returns in South Korea, India, and Taiwan, but they did not work in Japan (see Exhibit 1).
  2. Market participants generally had stronger reactions to the net percentage of upward and downward revisions in earnings estimates rather than the percentage change of the consensus estimate figures.
  3. Companies with poor earnings revisions tended to have more volatile returns, as market participants reacted negatively to companies with downward revisions in estimates.
  4. Earnings revision strategies tended to generate more alpha in the small-cap universe than in the large-mid-cap universe, although there was no strong sector or size bias.

Like other momentum strategies, the earnings revision strategies also had high turnover. In addition, the market-cap effect disrupted the signal from the earnings revision strategies. Therefore, implementing this strategy in combination with other fundamental factors and alternative weighting schemes would be essential to capture alpha. To find out more, please see the full report.

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