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U.S. Equities’ Resilient Run

Is Fixed Income Failing? It May Be Time to Look at the Index

Value Resurgent

Commodities on the Front Foot in January

On Schedule

U.S. Equities’ Resilient Run

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Fei Wang

Senior Analyst, U.S. Equity Indices

S&P Dow Jones Indices

It has been a tricky start to 2022, with drawdowns in many segments of the equity markets. Stocks have experienced divergent performances amid varied earnings announcements, a surging energy complex, geopolitical risks, and expectations for interest rate hikes from the U.S. Federal Reserve. Though far from the same magnitude, recent returns have been reminiscent of March 2020. Indeed, the 29% monthly difference between the best- and worst-performing S&P 500® sectors in January 2022 was the highest since March 2020. Some market participants may be contemplating portfolio changes in response to recent drawdowns, but others may wish to consider the potential power of doing nothing.

Exhibit 1 shows that the performance of the S&P 500, S&P MidCap 400®, and S&P SmallCap 600®, as well as their equal-weight, sector, and style variations, was resoundingly positive over the three-year period ending Dec. 31, 2021. Although the past three years offered their fair share of sentiment-shifting trends, from the market plunge due to onset of the COVID-19 pandemic, turbulence around the 2020 U.S. presidential election, and the closely watched response from the U.S. Federal Reserve to rising inflation, the S&P 500 posted a whopping 100% total return. Information Technology led the way with a 190% total return, and all but two indices finished with positive returns.

Exhibits 2-4 offer greater context by showing the distributions of three-year rolling annualized returns since June 1995 (Real Estate data goes back to 2016, when it became a standalone GICS sector). The charts show the interquartile range, mean, and median three-year rolling total returns for each index. The whiskers extend to the maximum and minimum values, and the latest returns are annotated as dots. Across the size spectrum, recent returns for most indices were higher than their respective 75th percentiles, with particularly strong returns—by historical standards—coming from a number of S&P 500-based indices.

For example, Exhibit 2 shows that recent three-year returns for the S&P 500 and most of its related indices were well above their long-term averages, except for the Energy, Utilities, and Pure Value indices. By percentile ranking, the S&P 500 (95%), S&P 500 Equal Weight (97%), S&P 500 Materials (99%), S&P 500 Real Estate (100%), and S&P 500 Growth (96%) are all ranked above 95% percentile in their respective history.

Exhibit 3 shows that the recent three-year performance for the S&P MidCap 400 and its related indices were also typically above their historical averages. The S&P MidCap 400 Industrials and Consumer Discretionary sectors posted particularly prominent returns relative to their respective historical returns, ranking in their 98% and 99% percentiles, respectively.

Exhibit 4 tells a similar story for the S&P SmallCap 600 Indices. All but three indices posted above average three-year rolling total returns, with the Information Technology sector’s returns within touching distance of its maximum.

The strong performance across the U.S. equity capitalization spectrum in recent years demonstrates the potential power of tracking the U.S. equities market. Given the challenges of successfully timing the market, some may wish to remember that time in the market could be more important than timing the market.

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

Is Fixed Income Failing? It May Be Time to Look at the Index

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Brian Luke

Senior Director, Head of Fixed Income Indices - Americas

S&P Dow Jones Indices

Last year wasn’t the best time to hold bonds. Nearly every equity market delivered solid gains in 2021, while the S&P U.S. Aggregate Bond Index fell 1.4%. Nevertheless, flows into fixed income products such as ETFs were firmly positive. The leading asset gatherer was total market-type ETFs, with one in every three dollars newly invested in U.S. fixed income ETFs during 2021 allocated to the “aggregate” category.

This is perhaps unfortunate, as the “aggregate” bond indices largely excluded some of the best-performing segments last year, as Exhibit 1 shows. This anomaly isn’t new, but it is newly causing providers to openly question the traditional thinking of fixed income indexing.

Fixed income investors have long measured the bond market with an aggregate-type index. As the name would imply, the largest portions of the bond market are combined into a single index. In simpler times, this worked: the majority of the bond market consisted of Treasury, government agency, corporate, and collateralized bonds. However, newer segments that are designed to protect investors from inflation (TIPS), interest rate risk (duration hedged and floating rate bonds), and taxes (munis) are excluded. These newer segments, including inflation-linked, high-yield, and global U.S. dollar bonds, have grown in size and scale over the past decades. Nowadays, a typical U.S. aggregate index accounts for only about half of the U.S. bond market, as reported by SIFMA.

Making an analogy to equities, this is akin to excluding stocks because they operate in breakthrough industries that didn’t exist 20 years ago. And, just as avoiding new equity industries can impair performance, last year, the half of the market tracked by aggregate bond indices happened to represent the worst-performing portions of the bond market (see Exhibit 1).

Investment managers, particularly those managing active funds, have moved beyond these core holdings to create “core-plus” accounts. These strategies allow for flexibility to buy non-aggregate securities like inflation-linked and high-yield bonds. Allowing for out-of-index trades opens up the opportunity set but, with the benchmark still anchored to its old rules, a potential mismatch arises in performance evaluation and risk management.

The practice of measuring managers’ performance against core and core-plus categories is recent, yet roughly half of active bond managers are placed in the category. This schism in the largest fixed income category has taken place in the mutual fund world, while the largely passive ETFs have remained anchored to the old index ways. Yet, investment flows into active fixed income ETFs, while small, are double that seen in the equity market (see Exhibit 2). This could be partly due to the flexibility active managers enjoy, as well as the gaps in traditional fixed income benchmarks. Readers of our blog should know better, though. According to our latest SPIVA® U.S. Scorecard, which measures performance of active managers against their benchmarks, the majority of fixed income managers failed to beat their assigned benchmarks in the 3-, 5-, and 10-year horizons.

Despite their long-term underperformance, the past year has been favorable to the large majority of active fixed income managers, at least if their performance is to be compared to traditional aggregate indices.

But traditional aggregate indices may, like their active alternatives, benefit from casting a wider net. As they do, passive bond funds could move to incorporate rules-based, systematic, and transparent return-enhancing bond strategies, such as inflation protection, credit premia capture, and curve strategies (such as carry, roll, and yield enhancement). For that to happen in indices, a new breed of index may be required, and the timing for that solution looks promising.

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

Value Resurgent

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Craig Lazzara

Managing Director, Core Product Management

S&P Dow Jones Indices

This year marks the 30th anniversary of the launch of indices designed to distinguish growth and value investment styles. Investment managers had classified themselves as growth or value specialists (among other possible differentiators) before 1992, but until then it wasn’t possible to evaluate a value manager against a systematically defined value benchmark or a growth manager against a growth benchmark. (Such comparisons have not generally been happy ones for active managers, but that’s a story for another day.) As with the S&P 500®, style indices, used initially as benchmarks, also came to underlie investment products by which growth and value exposure could be indicized.

Exhibit 1 compares the performance of the S&P 500 Growth Index and the S&P 500 Value Index. When the line on the graph is rising, Growth is outperforming Value, and vice versa when the line is falling.

Growth has outperformed since 1995, although it’s obvious that leadership has shifted between the two styles periodically. Given that the last 10 years have been largely dominated by Growth, and given the historical tendency for leadership to rotate, it’s not surprising that many market participants wonder when Value will once again take the lead. It has been a frustrating wait.

I confess that I am among the frustrated. Observing that between September 2020 and May 2021 Value (up 31.6%) had outperformed Growth (up 14.2%), I brazenly suggested that perhaps the long-awaited turn had come. My temerity was rewarded by a six-month streak in which Growth outperformed Value in five months. (The final score was Growth 19.1%, Value -0.8%.)

But since the beginning of December 2021, Value has once again assumed the lead. For the last two months, S&P 500 Value has scored a total return of 5.3%, while S&P 500 Growth has lost 6.1%. As Exhibit 2 makes clear, Value has dominated Growth across the capitalization range.

Most style index series are designed so that growth and value together compose the parent index; this necessitates their holding some stocks that are not obviously in either the growth or value camp. For clients who prefer a more concentrated approach to style, the S&P 500 Pure Value Index includes only names with the highest value scores, and analogously for the S&P 500 Pure Growth Index. Historically, when Value is outperforming Growth, typically Pure Value is outperforming Pure Growth by more, and Exhibit 3 shows that this pattern has continued during Value’s recent recovery.

Of course, we don’t know how long Value’s dominance will last—the historical record has included periods as short as six months (March-August 2009) and as long as 50 months (April 2003-May 2007). Owners of value indices obviously hope for the latter outcome, but even the former leaves room for additional outperformance.

 

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

Commodities on the Front Foot in January

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Fiona Boal

Head of Commodities and Real Assets

S&P Dow Jones Indices

The strong inflation tailwind that supported commodities in 2021 has bled into 2022, as the S&P GSCI started the year on the front foot, up 11.6% in January. In contrast, the S&P 500® fell 5.2% over the same period. Inflation has traditionally helped commodity markets. Commodities have also historically been a good hedge against inflation. Low inventories and robust global GDP growth, combined with continued supply bottlenecks, have been supportive for commodity prices. On the downside, tighter monetary policy (i.e., a less accommodating U.S. Fed) could strengthen the U.S. dollar and create headwinds for commodities prices as the year goes on.

The S&P GSCI Energy was up 18.4% over the month. Brent oil surged above USD 90 per barrel for the first time in seven years, as investor appetite for inflation-sensitive assets remained elevated and the market agonized over Russia-Ukraine tensions. Global oil inventories are at tank bottoms and geopolitical risks have exacerbated the current imbalance. On paper, OPEC+ is still planning to bring back 400,000 barrels per day (BPD) of production each month between now and September, but in reality, the production increases are forecast to be closer to 200-250,000 BPD each month due to underproduction and underperformance across several member countries. Global natural gas markets also continue to be roiled by geopolitical tensions. The S&P GSCI Natural Gas rallied 40.5% in January. Escalating tensions between the West and Russia over Ukraine raised concerns about Russian gas flows to Europe, prompting the European Commission and the U.S. to investigate alternative supplies.

Meanwhile, the green energy transition is not fading. Many commodities will continue to benefit from incremental demand, while other commodities, such as oil, will likely suffer from low investment. Aluminum and nickel led the S&P GSCI Industrial Metals up 2.6% over the month; both are metals that will continue to benefit from the move to more sustainable energy sources.

After 2021 showed the largest drop in six years, gold prices were down a further 1.9% in January, a relatively admirable performance compared with many other assets. The S&P GSCI Palladium was one of the best performers across the commodities complex in January, up 23.2%. Tensions between Russia and the West over Ukraine have heightened concerns over supplies of the metal used in catalytic converters.

Across the grains complex, corn and soybeans were supported by dryness concerns in South America, which has the potential to boost demand for U.S. crops later in the current crop year. Despite the fact that forecasts of global wheat supplies have risen, the risk of supplies being disrupted by the Russia-Ukraine standoff remain elevated. The S&P GSCI Agriculture ended the month 4.4% higher.

The S&P GSCI Livestock was up 1.9% over the month. A rally in lean hog prices was attributed to a slowdown in hog slaughter and robust demand in the U.S., as consumers return to the office and are eating away from home. The S&P GSCI Lean Hogs rallied 8.0% over the month.

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

On Schedule

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Craig Lazzara

Managing Director, Core Product Management

S&P Dow Jones Indices

The poet tells us that in spring, a young man’s fancy lightly turns to thoughts of love. Experience tells us that in January, an active manager’s fancy turns to thoughts of triumph.

Earlier this month, we learned that 70% of the institutional investors questioned in a recent poll thought that “markets will favor active management” in 2022. A number of reasons were cited for this belief, prominent among them the high level of concentration in some equity indices. Interestingly, this forecast of imminent active success is just the latest link in a long chain of similar predictions. For example:

  • We were told that falling correlations would produce a “stock-picker’s market” in 2014.
  • A year later, some active managers asserted that, with the market near then-all-time highs, active managers in 2015 were needed to mitigate portfolio risks.
  • More recently, it was claimed that active managers would outperform passive benchmarks due to the high level of volatility in 2019.

What did 2014, 2015, and 2019 have in common? In each of those years, a majority of U.S. large-cap active managers underperformed the S&P 500®. Indeed, of the 20 years for which SPIVA® data exist, a majority of large-cap managers outperformed only three times (most recently in 2009). The records for mid- and small-cap managers, and for active managers outside the U.S., are equally disappointing.

In other words—active managers frequently predict that we are, or soon will be, in a “stock-picker’s market,” but the stock-picker’s market, like the fabled Brigadoon, almost never arrives. Whenever you hear a forecast that this will be the year in which active management is vindicated, here are some questions for the forecaster: If you know that active management will outperform this year, did you know that passive would outperform last year? If you knew, why didn’t you say so then? And if you didn’t know then, why should we believe that you know now?

You may end up with fewer friends, but you’ll have more clarity on an important investment issue.

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