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Bye Bye Bull Market: Reaction to Coronavirus

Key Takeaways from the 10th Annual Australian Indexing & ETF Masterclass

The S&P Eurozone Paris-Aligned Climate Index Concept: A Greenwashing Minimization Approach to High Climate Impact Sector Neutrality

No Gas Left in the Tank for Energy Equities

The Virtue of Protection

Bye Bye Bull Market: Reaction to Coronavirus

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Hamish Preston

Associate Director, U.S. Equity Indices

S&P Dow Jones Indices

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The last few weeks have definitely felt like a “where were you when…?” moment as coronavirus fears spread around the world and many people’s day-to-day lives have been disrupted.  Amid the anxiety and disruption, global financial markets nosedived, sending all major equity indices tumbling, VIX® soaring to levels not seen since the financial crisis, and yields on U.S. Treasuries falling to record lows.

Highlighting just how long it feels since the S&P 500® notched its latest all-time high closing price level on February 19th, the benchmark officially entered correction territory – measured by a 10% decline from its recent high – at breathtaking pace (6 trading days) towards the end of February.  Precipitous falls this month – the 9.51% plunge on March 12th represented the index’s worst daily return since Black Monday in 1987 – then cemented the end of the longest bull market in historybull markets don’t die slowly but with a bang.

The turnaround in market sentiment also impacted smaller U.S. companies: while the S&P 500 sat 27% lower than its all-time high at last Thursday’s close, the S&P MidCap 400 (-32%) and the S&P SmallCap 600 (-34%) both fell more over the same period.  Given smaller companies’ revenues are typically more domestically focused, and so are usually more reliant on the domestic consumer and the health of the domestic economy, recent returns may reflect increasing expectations for a slowdown in the U.S. economy and the relative difficulty smaller companies may have in navigating such a scenario.

More broadly, fears surrounding coronavirus contributed to 20% declines in all but three U.S. sector indices between February 19 and March 12.  Energy companies were particularly hard hit given the recent moves in oil.  And although Friday’s gains offered some respite – the S&P 500 (+9.32%), S&P 400 (+8.46%), and S&P 600 (+8.18%) posted their best daily total returns since October 2008, and all sectors rose, as the U.S. administration set out plans for containing the virus – there remains some way to go to recover prior losses.

So where do the recent market movements leave us?  Undoubtedly, the last few weeks have been extremely challenging as new information on the coronavirus has been priced in real time, contributing to sizable market moves.  But as Friday’s moves highlighted, market volatility can go both ways: larger market recoveries have typically followed larger declines.  Given the difficulties in correctly timing the market, keeping calm and avoiding knee-jerk reactions may be helpful.

 

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

Key Takeaways from the 10th Annual Australian Indexing & ETF Masterclass

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Stuart Magrath

Senior Director, Channel Management, Australia and New Zealand

S&P Dow Jones Indices

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On March 3 and 5, 2020, S&P Dow Jones Indices hosted its 10th Annual Australian Indexing & ETF Masterclass series in Melbourne and Sydney. The events saw over 200 financial advisers come together in a week that, until the week after, had been the most volatile for financial markets since the stock market rout of 1987. That advisers were willing to spend four hours on their professional development at a time when many clients would have needed reassurance to “stay the course” with their current portfolios, or to make any changes, is an extremely positive sign, particularly when so much of the content and discussion revolved around the client.

The delegates to our masterclass had the privilege of hearing Michael Jones, a U.S.-based financial adviser, share his thoughts on the experience that advisers in the U.S. underwent as they transitioned from a brokerage model (i.e., commission-based revenue) to a fee-based model, most commonly AUM related. Michael was a captivating speaker and eloquently described that transition, along with the benefits that accrued not only to clients, but also to financial advisers. The key benefit was that now advisers and clients had aligned interests to grow AUM. The Australian experience has been somewhat different, and Michael was at pains to point out that the U.S. experience was not a template for Australia, but that there may be some valuable learnings for the financial advice industry here in this country.

Due to increasing interest in environmental, social, and governance (ESG), our 2020 masterclass included a session on S&P DJI’s approach to this theme. Priscilla Luk, Managing Director & Head of Asia Pacific, Global Research & Design at S&P DJI, presented from Hong Kong via Skype and provided background on why investors around the globe should consider integrating ESG themes into their investment portfolios. Priscilla also addressed the international growth of ESG assets and why ESG data is so vital to successfully accomplish ESG integration.

“Masterclass Week” always provides an opportunity to hear directly from a large number of financial advisers, and in particular their “what keeps me awake at night” concerns. Apart from the conversations with advisers at the events, we also set a cracking pace to meet advisers in their offices during the week. Michael Jones was a participant at these meetings in Melbourne and Sydney, but also this year in Toowoomba, Queensland.

The overarching theme emerging from these meetings is that advisers are continuing to work through the implications for their businesses, and ultimately their clients, in the aftermath of the recommendations, as well as the heightened compliance requirements from the Hayne Royal Commission. These themes include the hard intellectual work of determining a firm’s value proposition to clients in a meaningful manner. This may include a focus on “asset gathering” and outsourcing “asset allocation” and “asset management” to third-party partners. Alternatively, it may include building their own model portfolios of ETFs, or even building bespoke blends of ETFs and direct equities and managed funds.

“Masterclass Week” is also the time of year for the release of our  SPIVA® Australia Year-End 2019 Scorecard. As in previous scorecards, the results show that it remains difficult for active managers to outperform their respective index benchmarks across most asset classes, with the exception of the Australian Equity Mid- and Small-Cap fund category. This result, however, was not persistent over the five-year period.

If you wish to learn more about the masterclass, or have a discussion around SPIVA, please email or phone me: stuart.magrath@spglobal.com, +61 (0)2 9255 9869.

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

The S&P Eurozone Paris-Aligned Climate Index Concept: A Greenwashing Minimization Approach to High Climate Impact Sector Neutrality

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Ben Leale-Green

Analyst, Research & Design, ESG Indices

S&P Dow Jones Indices

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In January 2020, S&P Dow Jones Indices released a paper for the S&P Eurozone Paris-Aligned Climate Index Concept (PAC Concept). The PAC Concept aims to align with the proposals of the EU Technical Expert Group on Sustainable Finance (TEG), as published in its Final Report on Climate Benchmarks and Benchmarks’ ESG Disclosure dated September 2019,[1] for the Paris-Aligned Benchmark—the more stringent of the two benchmarks proposed by the EU. Furthermore, the PAC Concept aims to align with the TCFD’s recommendations on Climate Related Financial Risks and Opportunities. Since publication of the paper, we have received a lot of feedback on our approach, particularly with respect to the application of high climate impact sector neutrality.[2]

The PAC Concept uses “Trucost[3] sector” data, which has been mapped to the NACE[4] sections defined as high emitting.[5] There are 464 “Trucost sectors,” which are based on revenue streams. Therefore, companies can have exposure to multiple different “Trucost sectors” and by extension, exposure to both high and low climate impact sectors. This can be seen in Exhibit 1, where more companies have a mix of high and low climate impact revenue streams than those with only low impact or only high impact.

The PAC Concept’s granular view on revenues from high climate impact sectors ensures the same revenues, per dollar invested, as the underlying index. This objective would not be achievable if we only used company-level sector classification. This helps to minimize any unintentional greenwashing from index design within the TEG proposed high climate impact sector framework when company classifications are applied, rather than revenue classifications. Constructing the index using sector classifications means index design can transfer weight into companies with far less exposure to high-climate-impact sectors, as opposed to companies with more carbon-efficient practices. The latter are likely to be at the forefront of the low-carbon transition.

There are revenues from both high and low climate impact sectors[1] in most GICS® sectors (see Exhibit 2). The same is observed within GICS industry groups (see Exhibit 3).

Exhibit 4 shows where large weights from Energy and Materials may have been placed within high climate impact revenue streams. The X axis shows the percentage of revenues coming from high climate impact sectors and the Y axis shows the difference in sector weight between the parent index and PAC Concept. The size of the bubbles represents the weight of each sector within the parent index.

We can see weight being taken from Energy and Materials. A lot of this weight appears to be redistributed into Consumer Staples and Health Care. These two sectors had slightly less exposure to high climate impact sectors; however, this was where much of the weight ended up. There was also an overweight of the Consumer Discretionary sector, which has high climate impact exposure.

GICS industry group analysis shows a similar story at the more granular level. Household & Personal Products, Pharmaceuticals, Biotechnology & Life Sciences, and Semiconductors & Semiconductor Equipment all saw overweighting, while having high exposure to high climate impact sectors.

[1]   The percentage of revenues has been calculated as the weighted average of the percentage of each company’s revenues from high climate impact sectors, weighted by their weight in the S&P Eurozone LargeMidCap.

[1]   The EU Technical Expert Group on Sustainable Finance Final Report on Climate Benchmarks and Benchmarks’ ESG Disclosure, September 2019. The final report will serve as the basis for the European Commission for the drafting of the delegated acts under Regulation 2019/2089.

[2]   Climate Impact Sector neutrality is mandated by TEG in its Final Report.

[3]   A part of S&P Global.

[4]   NACE (a French term “nomenclature statistique des activités économiques dans la Communauté européenne”) is a revenue-based sector classification used within the European Union.

[5]   High climate impact sectors as defined by the TEG in the Final Report.

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

No Gas Left in the Tank for Energy Equities

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Jim Wiederhold

Associate Director, Commodities and Real Assets

S&P Dow Jones Indices

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In our blog post from December 2019,[1] we highlighted the disparity seen last year between different sectors of the commodity futures and commodity equities markets. The second thing to watch highlighted the substantial 25% performance difference in 2019 between the S&P GSCI Energy and the S&P GSCI Equity Commodity Energy Index. However, so far in 2020, these different asset classes have moved in lockstep (see Exhibit 1). The other noticeable takeaway is the complete reversal of last year’s positive performance across the different commodity equities.

There were justified reasons for the disparity last year. In 2019, energy equities underperformed due to bearish market sentiment associated with high debt levels present across the sector. We highlighted how our colleagues at S&P Global Ratings expect the Energy sector to lead in terms of defaults over the next five years. This may prove to be correct much more quickly than expected, with crude oil prices plummeting below breakeven levels of production. Energy is so far the worst-performing sector in the S&P 500® this year, dropping initially due to the COVID-19 outbreak and then collapsing further by more than a six-sigma move after the end of the OPEC+ alliance. With Russia and Saudi Arabia engaging in a new market share battle, oil prices raced to decade lows. The highly levered U.S. energy names that comprise the S&P Equity Commodity Energy Index are now facing one of the toughest times in recent memory.

The S&P GSCI Energy was already the worst-performing commodity sector prior to the collapse in oil prices on March 9, 2020. Several negative catalysts that have been building over the past few years have arguably come to a head in the energy complex: the global push toward ESG-based investing is reducing investors’ appetites for companies with higher carbon emissions, U.S. shale oil production has expanded at breakneck speed, and the multi-year alliance of OPEC+ to prop up crude oil prices by production cuts has collapsed.

Unsurprisingly, the energy bond market has also taken a hit this week. In S&P Dow Jones Indices’ March 12th Daily Dashboard, Chris Bennet highlights the present concern in the energy credit markets, where the option-adjusted spreads for the S&P 500 Energy Corporate Bond Index are double the next-closest sector. For market participants looking for commodity exposure, it is important to consider the different instruments available to them, even in situations where the short-term performance impact of supply and demand shocks are similar.

[1] Commodities – What to Watch for in 2020.

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

The Virtue of Protection

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Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

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It remains to be seen what the full economic impact of the COVID-19 virus will be, but it is already clear that no equity market  has escaped unscathed.  (In fact, most of them have been scathed rather badly.) The Canadian equity market was humming along in 2020 through February 20, 2020, with the S&P/TSX Composite climbing 5.5% in almost two months. Since then, things have taken a decided turn for the worse, as the index dived 16.5%. Overall, the index is down 11.9% year to date through March 10.

It’s not surprising to see that the S&P/TSX Composite Low Volatility Index has managed to weather the stormy environment well. That’s what it was designed to do, by offering a shield in the bad times while still participating in the good times. Low Vol will typically go up less when the market is rising and go down less when the market is falling.

Since the February 20th peak, the low volatility index fell 11.4% compared to the 16.5% decline of the TSX Composite. This is expected; Low Vol should decline less than the market. But it also uncharacteristically outperformed when the market was doing well, up 8.1% compared to 5.5% for the parent index. This allowed Low Vol to gain an extra cushion for its performance year to date, outperforming the S&P/TSX Composite by an impressive 7.6% (S&P/TSX Composite: -11.9%, S&P/TSX Composite Low Volatility: -4.2%). This phenomenon isn’t limited to the Canadian market, the strategy offered a similar protection in U.S. equity markets as well.

 

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