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As goes January, so ... what?

A Return to the Golden Age?

S&P 500 On Pace For Best January Since 1989

Style Designed For Performance

Sea Change at the Fed

As goes January, so ... what?

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Chris Bennett

Director, Index Investment Strategy

S&P Dow Jones Indices

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“The more you look at ‘common knowledge’, the more you realise that it is more likely to be common than it is to be knowledge”

– Idries Shah, Reflections

Statements such as “sell in May and go away” can become accepted wisdom without always facing proper scrutiny.  Another aphorism, particularly timely at the present moment, is offered by “as goes January, so goes the year.”  The idea is that January provides a roadmap for the rest of the year; it sets the tone and begins the trend.  Recently, following a strong market performance in January 2019, experts have begun to assert that good times are likely ahead.

There is some historical support for the thesis that the market’s returns in the remaining eleven months of the year are predicted directionally by January’s returns.  Since 1897, if the Dow Jones Industrial Average (DJIA) ended January with a positive return, the returns for the rest of the year were positive 73% of the time.

However, if the DJIA was negative in January, it offered significantly less predictive power, with the returns for the rest of the year being negative only 45% of the time, and positive 55% of the time.  That is to say, the returns after a negative January had the opposite sign in a majority of cases.

So, rather than saying “as goes January so goes the year”, we ought to say, “If January goes up, the rest of the year will likely be positive.  But if January is a down month, flip a coin”, which is admittedly not as pithy.

Overall, including both positive and negative starts to the year, January has matched the direction of the remaining 11 months returns 62% of the time.  That doesn’t sound terrible; a .620 batting average would get you into the baseball Hall of Fame.  Unfortunately, we’re not playing baseball and 62% is not far above the 50% that guessing a coin flip might get you.

But the “January Barometer” faces a tougher test than a simple coin flip.  Historically, over the long-term, the Dow has gone up in more months (and more years) than it has gone down.   In fact, if we simply predicted that the returns from February through December were going to be positive, no matter what happened in January, it would have been a safer bet: from February to December, returns for the Dow have been positive 66% of the time, regardless of how January performed. 

So what should we take away from this?  I think we can conclude that the “January Barometer” belongs in the category of misleading “truisms”.  January is not a great predictor for the rest of the year, and simply predicting the market will go up has proved more prescient.  Timing the market is hard, and January will not make that any easier.

 

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

A Return to the Golden Age?

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Fiona Boal

Head of Commodities and Real Assets

S&P Dow Jones Indices

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It should be no surprise to seasoned investors that gold has regained some of its shine over recent months. A resurgence in investors’ appetite for so-called “safe-haven” assets has seen the S&P GSCI Gold rise by 11% since mid-August 2018 to the highest level since May 2018. Considering gold’s relative performance, which is arguably a more valuable comparison from a portfolio perspective, gold strongly outperformed U.S. equities during the final quarter of 2018 before giving back some of that outperformance, as U.S. equities rallied through January 2019.

There is certainly no lack of risk catalysts for those investors that are ascending the investment wall of worry at the start of the new year and considering increasing their tactical allocation to gold.

  • A delayed hangover from the sharp global equity market correction in late 2018 and the related uptick in equity market volatility (a proxy for the “fear factor” in any market).
  • Growing concern that the global economy is slowing, albeit from a relatively strong position.
  • A stalling Chinese economy at the same time as burgeoning debt levels that make a large stimulus push increasingly difficult for Chinese leaders to enact.
  • Expectations that the U.S. Federal Reserve may park or even reverse its rising interest rate regime (non-income-generating assets tend to perform better in lower interest rate and lower U.S. dollar environments).
  • Geopolitical turmoil ranging from the U.S. government shutdown, Brexit, and the ongoing U.S.-China trade war saga, to the more recent escalation of the political situation in Venezuela.

But as investors navigate through the myriad of financial risk factors that will shape the trajectory of gold prices over the coming months, it is important for them to differentiate between investor and non-investment demand for gold. Clearly, investor demand for gold has been strong, as illustrated by the flow of funds into gold-linked investment products, but physical demand from the jewelry sector—highly dependent on demand in India and China—has been less stellar. According to the World Gold Council, global jewelry demand was close to flat year-over-year in 2018. On a more positive note, an uptick in central bank gold buying for strategic reserves bodes well for the overall strength of demand. Central banks purchased 74% more gold in 2018 than 2017, for the second-highest annual total on record.

Gold has, at least temporarily, re-entered a golden period in the eyes of those investors looking for safe-haven assets to insulate their portfolios from any number of risks buffeting global financial markets. Gold’s ongoing performance will depend heavily on how quickly these risks dissolve or escalate but will also continue to be influenced by non-investment demand trends.

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

S&P 500 On Pace For Best January Since 1989

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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In the first seven trading days of 2019, the S&P 500 had its hottest start since 2003.  That happened following the Fed’s message that it was in no hurry to raise interest rates.  The Fed met again yesterday signaling it might end the interest rate increases, which pushed the S&P 500 up 1.55% for the day (Jan. 30, 2019).  This has put the S&P 500 on track to post its 9th best January on record since 1928, its best January since 1989, and its best month since October 2015 with a gain of 6.95% through Jan. 30, 2019.  In the years including the prior 8 top Januaries, the S&P 500 finished positively 6 times, of which 5 years had gains over 19%. However, the subsequent Februaries were only positive half the time with biggest gain of 5.99% in February 1975.

Source: S&P Dow Jones Indices

The S&P 500 had a notable turnaround in January after posting its second worst December on record.  While there were, and still are some major global uncertainties – both domestically and internationally – it seems like the market was being mainly driven by the Fed.  It wasn’t just the S&P 500 but was the entire U.S. equity stock market that was impacted.  All 42 segments of size, style and sector were positive, which has happened in just 11 prior months, last in March 2016.

Source: S&P Dow Jones Indices. Jan. data ending on Jan. 30, 2019.

Half of the 42 segments of the U.S. equity market are on pace to post their best January on record, using data starting Sep. 1989, the earliest available sector data.  Also, some sectors are on pace to post relatively strong record months, for example, the S&P 600 Real Estate and the S&P MidCap 400 Value are each targeting their 4th best month ever, with respective gains of 12.88% and 11.30%.  The S&P MidCap 400 gained 9.87% and S&P SmallCap 600 9.63%, both posting their best Januaries and beating the S&P 500, as they historically have in rebounds.  Energy was the best performing sector, and unsurprisingly (due to hedging,) large caps (+10.24%) lagged the smaller company performance (+18.67%) as oil rose from sanctions on Venezuela and supply cuts from Saudi Arabia.

Source: S&P Dow Jones Indices. Jan data ending Jan. 30, 2019

Lastly, value outperformed growth significantly, especially in small-cap and mid-cap segments.  While the S&P 500 Value only outperformed the S&P 500 Growth by 1.63% in January, the S&P MidCap 400 Value outperformed the S&P Midcap 400 Growth by 2.77%, the most since the 4.18% outperformance in November 2016.  Moreover, the S&P SmallCap 600 Value outperformed the S&P SmallCap 600 Growth by 3.28%, the most since 4.27% of value outperformance in February 2001, and the 10th biggest outperformance on record.

 

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

Style Designed For Performance

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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Style, the name for the value (growth) factor, is one of the oldest known investment factors.  It can be defined in different ways, but in the S&P Composite 1500 that includes the S&P 500, S&P MidCap 400 and S&P SmallCap 600, style is measured by growth and value along two separate dimensions, with three factors used to measure each style:

Source: S&P Dow Jones Indices

Once stocks are classified into value, growth or a combination of both, the stocks are weighted by market capitalization in the traditional style indices like the S&P 500 Growth and the S&P 500 Value.  Historically, one of these style indices almost always beats the S&P 500.  Going back to 1995, either growth or value outperformed the composite in every year except 2001. Source: S&P Dow Jones Indices

However, the winning style is not known in advance and both styles never beat the S&P 500 in the same year, so picking the winner might be like flipping a coin.  Combining them is difficult also, because only a specific combination that is 54% growth and 46% value produced a more frequently winning combination.  It beat the S&P 500 in 16 of 24 years, more than either style alone with growth winning 15 times and value winning 8 times.  On average, over this time frame, the growth excess return has been 1.3% whereas value has lost 1.4%; however, when growth or value won, its alpha in either style was 4.1% annually.

One way to possibly increase returns is to modify the constituents and weights.  A more modern design to style is used to construct indices like the S&P 500 Pure Growth and S&P 500 Pure Value.  Pure style indices include the stocks ranked in the top quarter of its style, without any overlap, so only about half the parent index is included in pure style.  The other key distinction is that stocks in style are market capitalization weighted versus the stocks in pure style that are weighted by their style ranking.

Source: S&P Dow Jones Indices

An example of the resulting constituents shows the pure style eliminates the stocks appearing in both styles of value and growth.  While both pure styles lost in 1996, 1997 and 2008, both won in 2000, 2003, 2004, 2005, 2007, 2009, 2010, 2012 and 2013.  On average when the S&P 500 Pure Value beat the S&P 500, it added 12.3%, and when the S&P 500 Pure Growth beat the S&P 500, it added 9.1%.

Source: S&P Dow Jones Indices

In order to explore the deeper reasoning of why pure styles outperform and by how much, S&P Dow Jones Indices recently hosted a webinar (replay here) with external content contributors from BDF, Ambruster Capital Management, Inc.,  and Cardan Capital Partners.  BDF pointed out that while style and factor investing is helpful over the long term, there are certain behaviors to be mindful of when implementing those strategies.  This is since tilting with factors can lead to outperformance compared to simple float market capitalization weighted benchmarks, but factors are not unique to one another.  Ambruster Capital Management supported this with a periodic table of factors showing the performance rotation with all factors outperforming the S&P 500 over the past 20 years.

In S&P DJI’s own research, pure style indices offer a way to more precisely tilt and provide a higher exposure to the desired style that is more representative of what an investor may be getting from an actively managed strategy.  Selection and weighting are the two key drivers of performance differences between style and pure style. The same factors used to select are used to weight, so there is an interaction effect.  Pure style indices have more discriminatory power (ie when value is beating growth). Style indices have market beta near 1.00, while pure style indices have market beta higher than 1.00.

Source: S&P Dow Jones Indices LLC. Index performance based on total return in USD. The average annual excess return from weighting scheme is calculated as the first column minus the second column. Past performance is no guarantee of future results. Table is provided for illustrative purposes and reflects hypothetical historical performance.

Finally, Cardan Capital Partners showed pure style is a more effective way to capture the old growth and value factors, but that it is important to use both value and growth rather than only value or growth.  When equally weighting growth and value across sizes, almost any of the pure style combinations achieved nearly the best case scenario of the traditional styles. In other words, the worst performers in pure style are near the top of the traditional styles.

Source: Cardan Capital Partners shown at S&P Dow Jones Indices webinar at: https://go.spdji.com/SizingUpYourStyleStrategiesWebinar2019?src=Replay

 

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

Sea Change at the Fed

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Today’s Fed announcement keeping the Fed funds target range at 2.25% to 2.5% was more than simply leaving rates unchanged for the moment. Behind the headlines are changes in their expectations for inflation and the economy and adjustments in their operating procedures:

  • The FOMC will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.
  • The Fed expects overall inflation and inflation for items other than food and energy to remain near 2%.
  • The FOMC views sustained economic expansion, strong labor markets and inflation near 2% as the most likely outcome.

Given this view of the economy and inflation, there is no need to raise rates unless conditions change. The Fed is dropping its plan for gradual rate increases.  It will be closely watching the incoming data, but it won’t rush to judgment.

Supporting this change are continued and gradual reductions in the still overly large Fed balance sheet combined with ample bank reserves that should help curtail any market volatility. The Fed manages the Fed funds rate by adjusting the level of excess bank reserves – the extent by which bank reserves exceed reserves required by regulations and deposit levels – and by setting the interest rate it pays on excess reserves held by banks. By assuring ample reserves, the Fed will be limiting the risk of the kind of market gyrations seen at the end of 2018.

Market expectations align with the Fed’s stance. The CME’s Fed Watch Tool calculates the probability of a rate increase at each FOMC meeting through January 2020. Through the end of 2019, the probability that the Fed holds the rate at its current target is 80% or more. Even in early 2020, the probability of keeping the rate only dips slightly to 73%.

Needless to say, there are no guarantees in anything financial. However, for the moment interest rates seem likely to stay close to where they are.

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