Indexology^® Blog

Since March 2020, the federal government has enacted four pieces of legislation to assist businesses and individuals weather the economic downtown triggered by the COVID-19 outbreak. According to the Congressional Budget Office (CBO), these four pandemic-related laws are projected to increase the federal deficit by USD 2.2 trillion in fiscal year 2020 and by USD 0.6 trillion in fiscal year 2021. Those amounts would represent 11% of nominal GDP in fiscal year 2020 and 3% in fiscal year 2021. In late April 2020, the CBO adjusted the projected deficit to be 17.9% of GDP in 2020 and 9.8% in 2021, figures that were 13.3% and 5.5% higher, respectively, than projected in the initial January 2020 report (see Exhibit 1).

Higher Fiscal Deficit, Higher Issuance of U.S. Treasuries

As stated in the latest U.S. Treasury quarterly refunding statement released on May 6, 2020, the U.S. Treasury has increased borrowing needs substantially as a result of the federal government’s response to the COVID-19 outbreak and expects to begin to shift financing from bills to longer-dated tenors over the coming quarters. In fact, the market size and average duration of outstanding U.S. Treasury securities had been steadily increasing even before the COVID-19 outbreak (see Exhibits 2 and 3). Now, both should continue to trend higher.

Markets’ Reaction to Increased Supply, So Far

Increased funding needs and the shift of some issuance to a longer tenor from U.S. Treasury bonds mean more duration supply from U.S. Treasury securities. How has the market weathered this increased supply and the expectation of more supply over the coming quarters?

As the Federal Reserve revamped its large-scale asset purchase program at the same time, the bond market has absorbed the supply fairly well. From March 11, 2020, to May 27, 2020, securities held outright by the Federal Reserve increased from USD 3.9 trillion to USD 5.9 trillion. Exhibit 3 shows the 10-year U.S. government bond yield and rolling one-month realized yield volatility (annualized) since March 1, 2020. The 10-year U.S. Treasury yield jumped by 50 bps within a couple of days in mid-March 2020, but since then it has been trading in a tight range. Realized yield volatility has dropped back to the norm of the post-GFC low.

Looking Ahead

So far, the Fed’s bond purchasing program has been successful in capping yield and keeping yield volatility low. However, the substantial increase in the supply of U.S. Treasuries has opened up the upside risk of interest rates significantly, particularly given the Fed’s reluctant stance on negative rates. Looking forward, U.S. Treasury auctions and their results will continue to be closely monitored by market participants to gauge market appetite for duration supply.

The S&P 500^® has had a wild ride in 2020. The index hit an all-time high in February, then dropped 33.8% to the bottom in March due to the COVID-19 pandemic, and then rallied 32.6% by May 22. During this turbulent time, the S&P 500 Pure Growth, while declining along with markets, ultimately outperformed its benchmark by 4.92% (see Exhibit 1). The following analysis investigates attributes of this outperformance.

The S&P Pure Growth Index Series uses the following three components to define overall pure growth scores, and constituents are weighted based on their style scores:[i]

• Three-year change in earnings per share (excluding extra items) over price per share;
• Three-year sales per share growth rate; and
• Momentum (12-month percentage price change).

Fundamental Risk Factor Exposure

To better understand the characteristics of the S&P Pure Growth Index Series, we use a commercially available fundamental risk model to capture risk exposures. We measure active exposures of the S&P 500 Pure Growth relative to the S&P 500 (see Exhibit 2).

The S&P 500 Pure Growth had the highest positive tilt toward growth (0.36), followed by liquidity (0.35), medium-term momentum (0.19), and market sensitivity (0.19). Results were broadly in line with the index design . Moreover, the S&P 500 Pure Growth constituents tended to have higher return volatility, higher leverage, and better profitability.

On the other hand, the index was most underweight to the dividend yield factor (-0.45), followed by the size (-0.28) and value (-0.16) factors. This means that companies in the S&P 500 Pure Growth had lower dividend yields, tended to be smaller size, and had higher valuations than companies in the S&P 500 universe.

Sector Exposure and Performance Attribution

We next decompose excess returns of the S&P 500 Pure Growth into sector allocation and security selection of index constituents.

From Exhibit 3, we see the index was historically overweight in Information Technology (12.80%), Consumer Discretionary (6.19%), and Industrials (4.92%). In contrast, it was underweight in Consumer Staples (-6.72%), Health Care (-6.68%), Financials (-5.30%), and Communication Services (-4.67%) relative to the S&P 500.

The total performance effect was about 5%, with almost half of that coming from sector-allocation effects (2.36%). Information Technology and Financials had the highest sector effects of 2.00% and 1.29%, respectively. On the other hand, more than half of the outperformance came from selection effect (2.66%). Selection effect measures added value of security selection within a sector. The results showed that the methodology of the S&P 500 Pure Growth led to better-performing securities.

In conclusion, the S&P 500 Pure Growth outperformed its benchmark during this volatile period. This was mainly driven by positive exposure to growth and momentum and negative exposure to dividend and earning yields. Overall, sector allocation and security selection contributed to the outperformance.

[i] The detailed factor definition and index construction are laid out in the S&P 500 Pure Growth Methodology.

On May 20, 2020, my colleagues and I sought to address some questions about dividends and the viability of tried and true approaches to dividend income.

During that session, Craig Lazzara, Ari Rajendra, and Howard Silverblatt of S&P Dow Jones Indices (S&P DJI) joined me to address:

• The current state of dividends across the globe,
• A deep dive into the ups and downs of dividend payers and dividend growers across sectors and regions, and;
• Historical perspectives that help assess the future viability of index dividend strategies.

A replay of that information session, which incorporated questions submitted during registration, is available at https://on.spdji.com/webinars. We received more questions during our session, and I thought it would be useful to publish the additional questions and provide answers as a follow-up to the session.

Q: What is the current yield of the different S&P DJI dividend strategies discussed in the presentation? How do you see its range going forward?

A (Ari Rajendra): While we can’t speculate on the range going forward, the data in Exhibit 1 provides a relevant perspective on the range of dividend yields for different S&P Dividend Aristocrats^® Indices.

Q: Ari, can you go into a bit more detail on the dividend chart you showed (see Exhibit 2)? Are you assuming companies that took government money will cut or suspend dividends?

A (Ari Rajendra): No assumptions were made in the analysis; it was based on public announcements at the time of writing. If a company announced a cancellation or suspension as a result of taking government money, then it would be accounted for with no forecast made.

With respect to Exhibit 2, we grouped index constituents into four categories—announced drops, cancel/decrease, increase/maintain, and unknown. When a company postponed or not announced its dividends, we grouped them under the unknown category with no speculation on likely action.

Q: Do we need a COVID-19 index that would cater to companies adversely affected by COVID-19?

A (Craig Lazzara): The Index Investment Strategy team at S&P DJI produces monthly index dashboards. The S&P Select Industry Dashboard shows the industries that were most adversely affected by COVID-19 across the three-month and YTD return categories displayed in Exhibit 3. Many of these industry-specific indices are tracked by an ETF.

A (Peter Roffman): We’re also examining the concept of COVID-19-based investing, and we’ve noted that COVID-19 has inspired new index concepts across a variety of areas, including COVID-19 coping and recovery industries, as well as ESG indices.

Q: As I am listening to this session, I am seeing that the S&P 500^® Dividend Aristocrats was down about 16% versus the S&P 500, which was down 8%. Any comments on why the defensive characteristics discussed in the informational session aren’t showing?

A: Our colleague, Tianyin Cheng posted a recent and detailed analysis on why dividend indices underperformed during the coronavirus sell-off, available on the Indexology^® Blog at https://www.indexologyblog.com/2020/05/15/why-did-dividend-indices-underperform-during-the-coronavirus-sell-off/.

Q: Do you believe COVID-19 first hitting Europe and China had any impact on the timing of suspensions (higher globally) versus the U.S.?

A (Ari Rajendra): I’m not sure we can conclusively say whether timing has been the driver of the regional differences. Between the UK and U.S., for example, the peak of the pandemic was almost concurrent. Broadly, we could say that the U.S. equity market had been much stronger than its global peers coming into this crisis. That said, the complexity of global supply chains and simultaneous fall in consumer demand may eventually result in this being a global issue rather than a regional one.

We greatly appreciate the engagement of the more than 600 people that registered for our dividend information session, as we seek to meet your needs for information and education. I recommend that North American-based advisors bookmark https://spdji.com/topic/financial-advisors-us, where we curate the latest content for your interests.

The SPIVA® Canada Year-End 2019 Scorecard was released recently. Despite the strong performance of broad equities, 2019 proved to be yet another challenging year for active funds in Canada. Here are a few highlights from the report.

Strong Market Performance Did Not Translate to Active Fund Outperformance

The S&P/TSX Composite posted its highest annual return (22.9%) since 2009, ending a decade-long bull run that saw a total gain of 94.9%. Amid this historic bull market, however, 92% of Canadian Equity funds underperformed their benchmark in 2019 and 86% underperformed over the past decade.

Similarly, smaller-cap names in the S&P/TSX Completion gained 26.1%, setting a high bar for active managers to surpass—84% of Canadian Small-/Mid-Cap Equity funds underperformed the benchmark. However, over the long term, this was the best-performing category relative to the benchmark—30% of managers outperformed in the past decade.

International Equity Funds Fared Better, but Not in the Long Term

Funds with a more international flavor did better in 2019 than their domestic counterparts. International Equity funds performed the best across all categories, with 57% underperforming the S&P EPAC LargeMidCap. Longer-term results continued to disappoint, however, as 85% of International Equity funds underperformed over the 10-year period.

Larger Funds Outperformed Smaller Funds in Most Categories

Across the seven fund categories and four investment horizons studied, 23 of the 28 results showed higher asset-weighted returns than equal-weighted returns, indicating that larger funds outperformed smaller ones in general.

Conclusion

Some market participants may hope that they are able to find outperforming active managers. Our SPIVA scorecards continue to highlight the difficulties of beating the benchmarks, and Canadian active funds are no exception.

Bullish sentiment propelled the S&P GSCI higher by 16.4% in May, its best monthly performance in 11 years. The broad commodity index’s more than 50% exposure to energy was a key contributor to its performance. Energy led the way, with the WTI-based S&P GSCI Crude Oil up 55.0%, bouncing impressively off the lows in April. Despite economic data points, like U.S. consumer spending dropping the most on record, commodities posted an overall strong month. Industrial and precious metals exhibited positive gains, while agriculture and livestock were mixed.

The S&P GSCI Energy rose 35.2% in May, completely retracing the poor performance in April. As countries slowly opened from lockdowns, expectations of a pickup in demand coincided with voluntary and involuntary production cuts. Already in a dire situation pre-pandemic, there are now expectations for a wave of bankruptcies in the U.S. shale space, further adding to the production cuts. Markets will be focused on the June OPEC+ meeting for clues regarding further coordination to rebalance the oil markets. The S&P GSCI Natural Gas was the one laggard in the energy space, down 16.7% on the month, due to drastically less seasonal demand and rumblings of storage space becoming increasingly full.

In the metals complex, all eyes were on iron ore, with the S&P GSCI Iron Ore jumping 23.4%. Growing fears about the security of Brazilian iron ore exports, given the growing number of COVID-19 infections among miners, combined with strong Chinese demand for the steel-making ingredients to push iron ore prices through the USD 100 per ton level at the end of May for the first time in 10 months.

The S&P GSCI Precious Metals rose 4.2% in May. While gold continued its impressive rally, it was silver that shone brightest over the month. The S&P GSCI Silver rallied 23.6%, buoyed by supply disruptions due to lockdowns in major silver producing countries, such as Peru and Mexico, and strong demand for silver by silver-backed exchange-traded funds. Silver, which is used in items like microchips and solar panels, has more industrial applications than gold and tends to underperform during recessions and outperform when economies expand.

One would think with the amount of baking occurring in the U.S. during lockdown, grains would display some bullish undertones. However, this was not the case, as the S&P GSCI Grains fell 0.4% in May, with market participants focused on record U.S. supplies and the reignition of the U.S.-China trade war. The International Grains Council raised its production forecast for the 2020-2021 season by 12 million metric ton, while cutting its consumption outlook by 4 million over that period. The S&P GSCI Wheat fell 0.7% but was one of the only commodities with YTD performance down only single digits.

The S&P GSCI Livestock gained 5.4% last month, with the S&P GSCI Live Cattle surging 10.1%. After posting a new 10-year low in April, the same week WTI prices dipped into negative territory, steer prices bounced back, as meatpacking plants in the U.S. dealt with bottlenecks caused by worker cases of COVID-19, while meat demand remained resilient.