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Efficient Markets and Irrational Exuberance

Simplifying Sustainability: Meet the S&P Sustainability Screened Indices

U.S. Treasuries Sold Off with Rising Breakeven Inflation in January

Why Clean Energy Now

How Carbon Weight Adjustment May Reduce Carbon Intensity among Asian Equities

Efficient Markets and Irrational Exuberance

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

Recent headlines have reflected the extraordinary behavior of GameStop Corp.; the company’s stock rose from $18.84 at year-end 2020 to $325 at the close on Jan. 29, 2021, then declined to $90 in the first two trading days of February. At year-end, GameStop was the 314th largest stock in the S&P SmallCap 600®. By the end of January it had risen to #1. GameStop had been heavily shorted by hedge funds, and its rise was partly fueled by retail traders hoping to profit from a short squeeze.

Even a casual reader of our SPIVA reports will realize that most active managers underperform most of the time. One reason for this is that there is no natural source of outperformance, or “alpha.” The outperformers’ positive alpha depends entirely on the underperformers’ negative alpha. If the “game” of investment management is played between professional investors and what I affectionately call “undiversified amateurs,” we might expect the professionals to win more often than they lose, given their advantages in fundamental analysis, data access, and trade execution. These advantages might even be enough to allow most professionals to beat the market as a whole; in the 1950s and 1960s, this was often the case in the U.S. asset management business.

By the end of the 1960s, however, the tides had shifted. More and more assets were managed professionally, so that professionals were increasingly competing against each other, not against amateurs. When professionals become dominant, the amateurs who remain don’t generate enough negative alpha for the majority of professionals to outperform consistently. That, among other reasons, is why indexing started in the early 1970s—not a decade sooner or a decade later.

Which is not to say that amateurs are irrelevant. If the relative demise of amateurs helped fuel the rise of indexing, might their resurgence have the opposite effect? And what does the action in GameStop mean for market efficiency? I think the answer to these questions is “no” and “not much.” Consider:

  • Despite its 1,625% total return in January, GameStop remains a relatively small company. Its total market capitalization at January’s close was $21.2 billion, which is less than 1% of the market cap of Apple Inc., for the moment the largest stock in the S&P 500®.
  • If GameStop were a member of the S&P 500, its end-of-January ranking would have been #297.
  • It may be the case that retail demand can push GameStop up. Without continued demand, however, it won’t stay up, which may be the lesson of the first two days of February.

GameStop has been an interesting phenomenon among small caps, but without great significance for the market as a whole. Within its limits, the stock reminds me of Dr. Johnson’s characterization of Lord Chesterfield: “This man I thought had been a Lord among wits; but, I find, he is only a wit among Lords.”

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

Simplifying Sustainability: Meet the S&P Sustainability Screened Indices

How are mainstream, exclusion-based approaches to sustainability helping market participants align values and investment objectives? S&P DJI’s Mona Naqvi and iShare’s Sarah Kjellberg explore the design and range of potential applications for the S&P Sustainability Screened Indices.

 

 

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

U.S. Treasuries Sold Off with Rising Breakeven Inflation in January

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Hong Xie

Senior Director, Global Research & Design

S&P Dow Jones Indices

The year 2021 started with a continuous sell-off in the U.S. Treasury bond market. Starting on the second trading day of the year, yield on the 10-year U.S. Treasury Bond rose for five consecutive trading days by 23 bps until Jan. 12, 2021, when strong auction results for the 10-year note pulled the yield back from its high. In the second half of January, Treasuries’ yield continued to trade lower before it ticked up by the end of the month and found itself in a new range safely above 1%. The yield uptick happened toward the end of the month amid the comments of possible further ECB rate cuts, reassurance of no bond taper for “some time” by the U.S. Fed chairman, and equity market volatility.

From Aug. 4, 2020, to the end of January 2021, the 10-year U.S. Treasury yield rose 56 bps, accompanied by a steadily rising breakeven inflation rate and steepening yield curve. The 10-Year Breakeven Inflation Rate rose by 53 bps over the same period. (This rate reflects the market’s inflation expectation and is calculated as the yield difference between the 10-year U.S. treasury note and Treasury Inflation-Protected Securities [TIPS]). Real yields on TIPS across the curve are trading in negative territory. On Jan. 21, the 10-year TIPS new-issuance auction drew yield at -0.987%, only 13 bps higher than Jan. 4’s record low. The 2s10s yield curve steepened by 56 bps since last August, to the steepest level since 2018.

The Breakeven Inflation Rate rebounded strongly from the pandemic-induced low in March 2020. However, to put it into historical context, the 10-Year Breakeven Inflation, at 2.10% as of the end of January, is 9 bps above the 20-year average and 17 bps above the 10-year average. In comparison, economists are forecasting 2.1% for 2021 inflation, according to a January survey conducted by Bloomberg. The latest inflation data, released on Jan. 13, showed a small increase, to 1.4% year-over-year.

Possible factors contributing to higher market-based inflation may be a weak U.S. dollar, market expectation of more economic stimulus, hopes of an improved economic outlook following the start of the COVID-19 vaccine rollout, and the Fed’s signal of willingness to keep inflation running higher than the 2% target before hiking rates. On the other hand, inflation skeptics may point to the slack in the labor market and in the output gap. It remains to be seen if loose monetary policy and expansive fiscal spending will push inflation up or not, but inflation concerns will likely remain in investors’ minds in 2021.

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

Why Clean Energy Now

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Phillip Brzenk

Senior Director, Strategy Indices

S&P Dow Jones Indices

The U.S. Energy Information Administration (EIA) forecasts that power generation coming from renewable sources, such as wind, solar, hydro, and geothermal, should provide the majority of the world’s energy needs by 2050.1 The use of renewable energy has been increasing significantly over the last decade, however its current level of consumption still lags those of traditional sources of energy.

The primary driver behind the shift from traditional energy sources, such as petroleum, natural gas, and coal, to renewables comes from a “critical mass” of governments around the world looking to adopt policies that seek to lower the global carbon footprint.

Most notably, the landmark Paris Agreement—which calls to keep the increase in global average temperature to well below 2°C above pre-industrial levels and aims for a climate-neutral world by mid-century—was signed by nearly 200 countries and went into effect in 2016.2 There have been hiccups along the way, including the world’s largest economy and one of the largest carbon emitters, the U.S., withdrawing. However, the election of President Joe Biden in the 2020 U.S. election brought renewed hope given his campaign promises. Indeed, in the first few hours of taking office, the new president signed an executive order to have the U.S. rejoin the agreement in full.3

The renewable energy industry has grown over the last decade, rising from approximately 10% of all energy produced in 2010 to 22% as of November 2020 in the U.S.4 Despite this growth, significant additional changes are needed well before the mid-century mark to hit the stated climate goals. The need for increased renewable production and efficiency is perhaps evident, but more investment into equipment is needed as well to further support increased production and efficiency. In fact, the International Renewable Energy Agency (IRENA) has stated that annual investment in the renewables space must increase by almost triple to USD 800 billion between 2020 and 2050.5

Come 2050, electricity generation from renewables is expected to come from a well-diversified mix led by solar, wind, and hydro. Based on these projections, focusing on just one area of renewable energy would leave out significant exposure to the overall industry.

In addition, the clean energy push clearly needs to be a global phenomenon, as the growth in consumption through 2050 will primarily be from non-OECD countries.6 Therefore, having a global perspective when it comes to meeting the expected growth is useful.

With the surge in demand for renewable energy, companies in the clean energy space are poised for similar growth. How does one capture the theme and track the performance of clean energy companies? Launched in 2007,7 S&P DJI offers the S&P Global Clean Energy Index, which provides liquid and tradable exposure to 30 leading clean energy companies. The index attempts to represent the full clean energy ecosystem by including companies both on the production and the technology & equipment sides in the various segments of renewable energy across the globe.

 

1 https://www.eia.gov/todayinenergy/detail.php?id=42555#

2 https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement

3 https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/paris-climate-agreement/

4 https://www.eia.gov/electricity/monthly/current_month/january2021.pdf

5 IRENA and CPI (2020), Global Landscape of Renewable Energy Finance, 2020, International Renewable Energy Agency, Abu Dhabi.

6 Organisation of Economic Co-operation and Development (OECD).

7 The index was launched on Feb. 22, 2007 with a base date of Nov. 21, 2003.

 

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

How Carbon Weight Adjustment May Reduce Carbon Intensity among Asian Equities

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Liyu Zeng

Director, Global Research & Design

S&P Dow Jones Indices

In a previous blog, we reviewed the carbon efficiencies of Asian companies in comparison with their global industry group peers. In this blog, we examine the potential carbon intensity1 reduction on various Asian markets by incorporating a carbon weight adjustment to their respective S&P Global BMI index universes, following the S&P Global Carbon Efficient Index Series methodology. The S&P Global Carbon Efficient Index Series applies a carbon weight adjustment to companies within each GICS® industry group, which overweights (or underweights) companies with lower (or higher) levels of carbon intensity, while maintaining the respective industry group weights of their underlying indices.

The decile weight adjustment factor for each company is assigned according to its carbon intensity decile rank based on the S&P Global Carbon Standard and its carbon data disclosure status (see Exhibit 1). Companies in high-carbon deciles (i.e., low carbon intensities) are assigned positive decile weight adjustment factors. In addition, companies that publicly disclose their carbon emission numbers receive higher decile weight adjustments than those that do not disclose, within the same decile.

Furthermore, the decile weight adjustments are multiplied by industry group impact factors, which vary across high-, mid-, and low-impact industry groups. The industry group impact is defined by the spread of carbon intensities across companies in each industry group2 (see Exhibit 2). Carbon weight adjustments are more significant for companies in the high-impact industry groups (Energy, Materials, Transportation, Food, Beverages & Tobacco, and Utilities).

As shown in Exhibit 3, the carbon intensity of various Asian markets ranged from 167 (Japan) to 581 (India). Evidently, companies in high-impact industry groups had much higher carbon intensities than those in mid- and low-impact industry groups, and they tended to have the highest contribution to overall portfolio carbon intensity, despite the weighted-average carbon intensities of high-impact industry groups, which varied from 549 (Japan) to 1,901 (China). On the other hand, high weighting in high-impact industry groups, such as in Australia (31.6%) and India (28.7%), also drove up the overall portfolio carbon intensity.

Among various Asian markets, Japan and Korea had the lowest overall carbon intensities (167 and 202, respectively), which was largely caused by low weighting and low carbon intensities among high-impact industry groups. The opposite was seen in India and China, where the carbon intensities were much higher (581 and 471, respectively).

Applying a carbon weight adjustment to Asian market portfolios resulted in significant carbon intensity reductions ranging from 20.7% to 53.8%, compared with their respective market-cap-weighted market portfolios. The degree of carbon intensity reduction is largely determined by the difference in carbon intensities of companies in high- versus low-carbon deciles and the weights available for adjustment (from high- and low-carbon deciles) in the high-impact industry groups.

India and China, with high weighting in high- and low-carbon deciles and a high carbon intensity range in high-impact industry groups, had a carbon intensity reduction of over 50%. In contrast, Japan and Korea, with low weighting in low-carbon deciles and low carbon intensity range in their high-impact industry groups, had smaller reductions of 21.3% and 20.7%, respectively. Despite varying levels of carbon intensity reductions across markets, the vast majority of the carbon intensity reductions were contributed from the carbon weight adjustment on companies in the high-impact industry groups.

These results indicate that, even without any industry group weight bias, reweighting companies according to their carbon intensities and industry group impacts may achieve a significant carbon intensity reduction across Asian markets, with companies in the high-impact industry groups contributing most to the reduction.

1Company-level carbon intensity is calculated by Trucost. It is defined as a company’s annual greenhouse gas (GHG) emissions (direct and first tier indirect), expressed as tons of carbon dioxide equivalent (CO2e) in millions, divided by annual revenues. Portfolio level carbon intensity is calculated as the weighted average of company level carbon intensities.

2Each industry group is classified as high, mid or low impact based on the range of carbon-to-revenue footprints across the companies within that industry group in the S&P Global LargeMidCap. Industry groups with a range bigger/lower than 500/150 (CO2e / revenue) are considered high/low impact industry groups, while the rest are mid-impact industry groups.

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