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Energy Stays on Top in April

As U.S. Investment-Grade Corporate Bonds Push Toward Yields of 4%, Will Eurozone Corporate Bonds Ever Make it to Even 1%?

Energy Powers Small Cap And Value In April

Interest Rate Risk of Low Volatility Indices – Part II

Communicating Income: Lessons From Behavioral Finance

Energy Stays on Top in April

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Marya Alsati

Product Manager, Commodities, Home Prices, and Real Assets

S&P Dow Jones Indices

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The Dow Jones Commodity Index (DJCI) was up 2.9% for April 2018 and up 3.7% YTD, while the S&P GSCI was up 5.0% for the month and 7.3% YTD. Precious metals was the worst-performing sector in the indices and energy was the best.

Exhibit 1 depicts the month-to-date and YTD performance of the sector indices in the S&P GSCI.

Precious metals was down 0.4% for the month and flat for the year, weighed down by a strengthening U.S. dollar. Livestock’s decline of 8.9% YTD erased the gains it earned in 2016, when it finished the year up 8.4%. The loss was driven by price declines in lean hogs, which make up about 32% of the sector and were down 15.1% YTD because of ample global supplies.

The S&P GSCI Energy was up 6.5% for the month, and all the energy commodities were positive for a second consecutive month. Petroleum prices increased as U.S. drilling declined, a decline was seen in global oil stocks, and Saudi Arabia’s Crown Prince, Mohammad Bin Salman, announced to the press in March that Saudi Arabia will be working with Russia on a deal to extend control over major exporters over a period of one to two decades. In April, Brent crude was the best performer, up 8.7%, followed by heating oil, up 6.9%. Natural gas was down 0.1%, due to warming weather conditions.

Of the 24 commodities tracked by the S&P GSCI, 17 were positive in April. Exhibit 2 depicts the April performance of the single commodity indices.

Aluminum was the best-performing commodity in the indices, up 14.9% in April, after proposed sanctions on Russian aluminum producer Rusal were announced. Sugar was the worst-performing commodity in the indices, down 5.2% for the month and off 22.1% YTD, due to a global surplus.

Exhibit 3 depicts the performance for sugar and aluminum since index levels were rebased to 100 on April 30, 2008.

It can be seen in Exhibit 3 that the S&P GSCI Aluminum has reverted back to its late-2014 levels, when demand exceeded supply, while the S&P GSCI Sugar has reverted to its 1999 levels. To understand the concept of index levels, a hypothetical portfolio of USD 100 tracking an index based at 100 would increase by USD 20 if the index levels increased to 120 and decrease by USD 20 if the index level declines to 80.

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

As U.S. Investment-Grade Corporate Bonds Push Toward Yields of 4%, Will Eurozone Corporate Bonds Ever Make it to Even 1%?

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Heather Mcardle

Director, Fixed Income Indices

S&P Dow Jones Indices

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The European Central Bank (ECB) announced last Thursday, April 26, 2018, that it would maintain its monetary policy and bond-buying program, as growth in the eurozone slowed in the first quarter. The ECB corporate bond purchases have pushed yields in the region to their lowest since the financial crisis. Inflation targets in the region are not expected to be reached and monetary stimulation could continue for longer than expected. Corporate bond yields are dramatically lower than comparable U.S. and UK markets. Investors in the region have speculated on the effect a cut in monetary stimulus would have on the asset class. Today’s announcement continued the uncertainty and the likelihood that eurozone corporate bond yields are not poised to rise anytime soon.

The U.S. investment-grade corporate bond market has seen yields getting progressively higher with the U.S. Fed Rate hikes over the past year. The S&P 500® Investment Grade Corporate Bond Index, which is designed to measure the performance of U.S. corporate debt issued by constituents in the S&P 500 with an investment-grade rating, yielded 3.85% as of April 25, 2018—rising 74 bps year-over-year. Meanwhile, the S&P Eurozone Investment Grade Corporate Bond Index has seen its yield rise only 1 bps in the past year, going from a yield of 0.77% to 0.78%. The eurozone index yield sank to lows of 0.50% back in November 2017. The option-adjusted spread (OAS), which measures the spread over a risk-free rate (usually a treasury/government bond), for both indices has tightened in the past year between 8 bps and 16 bps, showing the effect the ECB’s bond purchasing program has had on eurozone corporates. German bunds have largely been range-bound in the sub 0.10% level, while U.S. Treasury yields have risen nearly 100 bps in the past year. Despite concerns that the asset class could be subject to a correction once the ECB switches monetary policy, and despite the attractiveness of higher rates in the U.S., a weaker-than-hoped-for European economy may keep corporates below the 1% level for longer than expected.

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

Energy Powers Small Cap And Value In April

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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In April, the S&P 500 (TR) gained 0.4%, ending its first consecutive monthly loss in almost two years, but the index is still down 0.4% year-to-date (ending April 30, 2018.)  Mid caps are also down for the year, -1.0%, after the S&P 400 (TR) lost 0.3% in April.  However, Small caps pushed into positive territory, up now 1.6% year-to-date, from the S&P 600 (TR) gain of 1.0% in April.

Source: S&P Dow Jones Indices

Overall, 6 of 11 sectors gained in large and mid caps while 8 of 11 gained in small caps.  Energy led the gains across the size spectrum with total returns of 9.4%, 13.4% and 16.6%, respectively in large, mid and small caps that more than tripled the next best sector’s returns (S&P 500 Consumer Discretionary gained 2.4%, S&P 400 Utilities gained 3.9%, and S&P 600 Telecommunications gained 5.9%.) It  was the S&P 500 Energy’s 17th best month on record since October 1989, and it gained most since Sep. 2017.  Consumer Staples posted its 28th worst month in history, losing 4.3%, making it the 3rd consecutive monthly loss and worst 3-month loss (-12.5%) since the 3 months ending in Feb. 2009.

Source: S&P Dow Jones Indices

Energy’s outperformance not only propelled small caps to outperform large caps (since smaller energy companies rise more with oil) but drove value to outperform growth.  The S&P 500 Value has 12.5% more energy than the S&P 500 Growth, which has nearly none. While the value outperformed growth across all sizes for the first time in 2018, the mid and small caps had a much greater premium (respective 1.8% and 1.3%) than the large cap premium at 0.2%.  The mid cap premium was the most since Nov. 2016 and the small cap was most since Sep. 2017.  It is also the first time large cap value outperformed growth for 4 of 6 months since the second half of 2016.

Source: S&P Dow Jones Indices

As shown at the end of 2017, when growth and large caps outperform as much as they did in 2017 (that was the most since 1999,) the trend reverses.  That’s what seems to be happening now.

 

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

Interest Rate Risk of Low Volatility Indices – Part II

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Phillip Brzenk

Senior Director, Strategy Indices

S&P Dow Jones Indices

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In a previous blog, we performed preliminary exploration of rising interest rate exposure of the S&P 500® Low Volatility Index. In this blog, we continue the analysis to see if there is a relationship between the magnitude of interest rate change and magnitude of active return of the low volatility index relative to the S&P 500. To do so, we run a regression line by plotting the historical monthly excess returns (y-axis) against the monthly interest rate changes (x-axis).

Looking at the trend line in Exhibit 1, there is a downward sloping, negative relationship between the degree of interest rate movements and the excess return of the low volatility index relative to the S&P 500. The regression equation, also shown in the chart, confirms the negative relationship.

The regression equation has a slope coefficient of -3.07 and an r-squared value of 8.8%. The coefficient indicates that for every 1% change in interest rate, the excess return of the low volatility index is expected to change by -3.07 times. For example, if interest rates rise by 1%, the relative return is expected to be -3.07%. Conversely, if rates decline by 1%, the excess return is expected to be 3.07%.

The r-squared value is the trend line’s “goodness of fit” to the data; in essence, it is the explanatory power of interest rate movements on excess returns. We note that the r-squared value is relatively low; however, the coefficient to interest rates is statistically significant. Ensuring that coefficients are statistically significant when it comes to factors that have low explanatory power, such as macroeconomic factors, on equity performance is especially critical. In this case, the t-stat of the interest rate change coefficient is -5.61, which is significant at the 99th percent confidence interval.

Combined with the findings in the first blog, we can conclude that, historically, the S&P 500 Low Volatility Index tends to be negatively affected by rising interest rates. In a subsequent blog, we will explore an alternative low volatility index strategy that is designed to reduce interest rate exposure while still preserving low volatility properties.

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

Communicating Income: Lessons From Behavioral Finance

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Warren Cormier

Executive Director

DCIIA Retirement Research Center

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In my recent book, The Behavioral Economics Approach to Winning New Clients (and Keeping the Ones You Have!), I offer a dozen recommendations to financial advisors charged with stewarding their clients’ assets to ultimately improve the relationship between client and advisor.  Several lessons are devoted to communication, specifically ways to employ trust, loss aversion and regret aversion when helping clients save for future goals, and most often, those goals are retirement goals.

The heart of any retirement discussion must include the role of today’s defined contribution (DC) plan.  DC plans today are not like yesterday’s supplemental, savings-oriented plans and the more we rely on these plans to provide a true retirement, the more we may also change our focus from wealth accumulation to a different goal such as an income-oriented goal.  Income-oriented goals are those targeting a specific standard of living, withdrawal rate, or income replacement ratio in retirement.  This shift in focus would require plan sponsors, practitioners and plan sponsors alike to change the way they communicate to and with each other; moving from a mere savings discussion to a discussion encompassing both saving and spending over one’s lifecycle.

When we communicate with clients (and/or DC plan participants), we must communicate in terms familiar and relevant to them.  Historically, the retirement industry has communicated from the wealth accumulation lens, focusing on growing an account balance or what stocks or funds to pick.  The problem with this communication approach is two-fold.  First, participants generally do not know how much money is enough for retirement.  Lump sum account balances are confusing – it may be more natural for participants to make decisions based on periodic amounts such as an annual salary or monthly bills.  Secondly, when participants do retire, their nest egg is probably the biggest amount of money they have ever seen, let alone have to manage.  This conundrum causes participants to exhibit either the illusion of wealth (spending too much too quick) or alternatively spending too little because they haven’t fully graduated from the savings mindset.

The retirement industry (financial advisors, plan sponsors, asset manager and index providers) can help participants by creating products and services that focus on retirement income rather than just wealth accumulation.  I am pleased to see a resurgence in new products, white papers, retirement income topics at conferences and regulatory proposals such as the Retirement Enhancement and Savings Act of 2018.  What’s needed now are innovative solutions designed to provide clarity in savings outcomes to help participants understand the risks they face as they progress to and in retirement.  I am confident that our industry will create these solutions and help turn America’s defined contribution system into America’s retirement system!

Video Link: https://www.assettv.ca/video/communicating-income-lessons-behavioral-finance

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