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The Hunt for Value With High Earnings Expectations in Asia

Inflation News and Fears

A Case for Dividend Growth Strategies Part 1

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

I’m Exhausted

The Hunt for Value With High Earnings Expectations in Asia

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Utkarsh Agrawal

Associate Director, Global Research & Design

S&P Dow Jones Indices

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In our previous blog, Earnings Revision Strategies in Asia, we discussed how those strategies performed in Asia. Although they worked well in various markets except Japan, there were some implementation challenges, such as high portfolio turnover and low liquidity for small-cap stocks. Therefore, implementing this strategy in combination with other fundamental factors with lower overall portfolio turnover may be more practical than implementing it as a single-factor strategy. Let us examine how an earnings revision strategy has worked historically in combination with a value strategy in the Asian market. The combination seeks to track the performance of undervalued stocks with high earnings expectations.

Adopting the S&P Enhanced Value Indices methodology,[1] we used earnings-to-price, sales-to-price, and book-value-to-price ratios to identify stocks that were relatively undervalued in comparison to the other stocks in the universe. Stocks with higher ratios were assigned higher value scores. We first selected a top quintile of stocks with the highest value scores from the universe.[2] From these stocks, we selected the top 70% of stocks with the highest earnings estimate diffusion, which is defined as the net percentage of upward and downward revisions in the earnings estimates.[3] We rebalanced the portfolios semiannually in March and September and weighted the portfolio members by their float-adjusted market cap.

With this sequential screening approach, the earnings diffusion strategy delivered return alpha over the simple value strategy in a majority of the Asian markets, with the most pronounced excess return in South Korea and Taiwan (see Exhibit 1). The annualized portfolio turnover was moderate, ranging from 80% to 100% over the back-tested period from March 31, 2006, to Sept. 30, 2017. Interestingly, despite the fact that the simple earnings revision strategy did not historically work in the broad Japanese market as noted in our research paper Do Earnings Revisions Matter in Asia, the earnings diffusion overlay delivered excess return on the value screened stocks in Japan. This implies that market participants in search of undervalued stocks in the Japanese market tended to care more about earnings revisions.

[1]   For more details please see: http://spindices.com/documents/methodologies/methodology-sp-enhanced-value-indices.pdf.

[2]   For each market, the universe comprised stocks with at least three analysts’ estimates. The indices used for each market were: S&P Australia BMI, S&P China A BMI, S&P Hong Kong BMI, S&P India BMI, S&P Japan BMI, S&P Korea BMI, and S&P Taiwan BMI.

[3]   Earnings diffusion was calculated over the previous six-month period as of the data reference date. For more details please see: https://spindices.com/documents/research/research-do-earnings-revisions-matter-in-asia.pdf.

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

Inflation News and Fears

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Two weeks ago inflation fears sparked by a surprise jump in wage gains sent the markets into a tail spin. This week will deliver two rounds of inflation news with the Consumer Price Index (CPI) on Wednesday and the Producer Price Index (PPI) on Thursday.  Month to month changes in both the CPI and PPI are usually quite small; large moves often reverse in subsequent months.  Moreover, measures of expected inflation don’t suggest a great deal of anxiety about rising prices.  Nevertheless, the recent market volatility will focus a lot of attention on this week’s inflation numbers.

The charts shown here provide some perspective on inflation. The charts show the year-over-year change in various inflation measures as well as measures of  expected inflation based on the University of Michigan Survey Research Center and the yields on five-year treasuries and TIPS.

The CPI (second chart) and PPI (third chart) do show an upward trend in inflation since 2015. This reflects rising oil prices in 2016-17 as well as an improving economy. But in both series increases in inflation appear to reverse.

Based on current surveys, the year-over-year increases in the CPI are likely to remain under 2%, the year-over-year increase in the PPI could top 2%. All these are similar to recent numbers.

The Core CPI excludes the volatile food and energy components from the CPI to give a better long term view of inflation

 

Even the overall CPI, including all components, doesn’t show any hints of a surging prices any time soon.

While the PPI is more volatile, it is not signaling any immediate problems.

Research and comments by various Federal Reserve officials point to expectations of future inflation as a principal determinant of future inflation. This chart shows that expectations have been stable over the last several months.

Finally, the future inflation rate implied by five year treasury notes and the inflation-protected treasury securities do hint that five years down the road, inflation will still be close to 2%.

All charts use data from FRED economic data, St. Louis Federal Reserve Bank.

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

A Case for Dividend Growth Strategies Part 1

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Tianyin Cheng

Senior Director, Strategy and Volatility Indices

S&P Dow Jones Indices

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There are two major types of dividend strategies:

  1. Dividend growers: those targeting stocks that consistently grow their dividends over time
  2. High dividend yielders: those focusing on stocks that pay a high dividend yield

In our paper “A Case for Dividend Growth Strategies,” we compared dividend growth strategies to high-dividend-yielding strategies and concluded that dividend growers, which tend to be higher quality companies, have generally shown greater resilience in unsteady markets and could address concerns about dividend stocks in a rising-rate environment, to some extent.

Take the dividend growth strategy built on the U.S. large-, mid-, and small-cap segments for example. The S&P High Yield Dividend Aristocrats® is designed to track a basket of stocks from the S&P Composite 1500® that have consistently increased their dividends every year for at least 20 years.

While the hurdle for index inclusion is 20 straight years of increasing dividends, the index average is 35.9 years. Additionally, there are eight constituents with over 55 consecutive years of dividend increases. This impressive consistency suggests a certain amount of financial strength and discipline, which may provide some downside protection in turbulent markets (see Exhibit 1).

Historical performance shows that the index provided some downside protection during bearish markets. Looking at the period from Dec. 31, 1999, to Dec. 29, 2017, when the market (as represented by the S&P Composite 1500) was down, the S&P High Yield Dividend Aristocrats outperformed the S&P Composite 1500 by an average of 161 bps per month. When we focused on the 15 worst-performing months for the S&P Composite 1500 during the same period, the protection provided by the S&P High Yield Dividend Aristocrats appeared prominent. Its monthly outperformance was 308 bps against the S&P Composite 1500 (see Exhibit 2).

Two other important characteristics of the index are more sector diversification and less value bias compared with the high dividend yielders. As a result, as markets shift from a value to a growth regime, the performance of the dividend growers would suffer less. These characteristics could potentially address the concerns surrounding the performance of high dividend payers in a rising-rate environment. Exhibits 3 and 4 illustrate the value and growth composition as well as sector composition of the S&P High Yield Dividend Aristocrats versus the S&P 500® High Dividend Index—a high-dividend strategy built on the S&P 500.

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

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.