Author: Sherifa Issifu

Sherifa Issifu is Senior Analyst, U.S. Equity Indices at S&P Dow Jones Indices (S&P DJI). Her team is responsible for providing insights and thought leadership on S&P DJI’s U.S. equity index suite, including the S&P 500® and The Dow®, and assisting with the development of new benchmarks for market participants. In her role, Sherifa works closely with the sales, channel, marketing and research departments.

Prior to that, Sherifa worked in Index Investment Strategy at S&P DJI, where she provided research and commentary on the entire S&P DJI product set, including U.S. and global equities, commodities, fixed income and economic indices. In this role, Sherifa became a frequent contributor to financial media outlets and was co-author of the S&P DJI Daily Dashboard and a regular presenter on the S&P DJI Weekly Index Strategy Update Call.

Before joining S&P DJI, Sherifa worked as an analyst for Citigroup in Global Markets and Securities Services, across asset classes and functions.

Sherifa attended Cardiff University, where she earned a bachelor’s degree in economics and management studies. Sherifa is also an affiliate of the Charted Institute for Securities & Investment (CISI) and holds the CFA Institute Certificate in ESG Investing.

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Equities

Magnificent Mid Caps and Sensational Small Caps

U.S. equities rose in 2023, with the mega-cap “Magnificent Seven” driving most of the S&P Composite 1500®’s 25% gain. While mega caps continued to outperform in January 2024, not all seven of the aforementioned group ranked highly. This has led to some market commentators looking to coin new phrases: “Sensational Six” or “Super Six” (the jury is still out on the new superhero-esque moniker, count and membership of our new set of mega caps).

Some market participants have sought to diversify their mega-cap exposure through the S&P 500® Equal Weight Index. Other smaller-size tools of diversification are the S&P MidCap 400® and the S&P SmallCap 600®, which have distinct characteristics and sector exposure from large caps.

U.S. small and mid caps have benefited from the small- and mid-size equity premium historically, outperforming the S&P 500 over the long run. Historically, there has also been a cyclicality among U.S. equity size ranges. While the S&P 400® and S&P 600® are smaller than large-cap U.S. equities, when looking abroad, the U.S. mid-cap and small-cap markets are equivalent to entire countries’ entire equity markets. Exhibit 1 shows that the S&P 400 would rank as the fourth-largest country in the S&P Global BMI and the S&P 600 is larger than South Korea (all based on float-adjusted market capitalization).

Differences in sector exposure among the U.S. equity size segments have also meant that the S&P 400 and S&P 600 are more domestically focused than the S&P 500, with higher weights in Industrials, Financials, and Real Estate. This has historically meant greater sensitivity to U.S. macro indicators, such as GDP growth, than large-cap stocks.

The differences in sector composition shown in Exhibit 2 in part help explain the non-perfect correlation (see Exhibit 3) between the S&P 500 and smaller-size-focused U.S. equity indices. These differences in sectors and correlation may present an interesting option to diversify with the S&P MidCap 400 and the S&P SmallCap 600, with a potential to reduce risk-adjusted return compared with the S&P 500 alone.

Interest rates may provide a tactical opportunity to diversify the large-cap S&P 500 with the S&P 500 Equal Weight Index, S&P MidCap 400 and S&P SmallCap 600, based on their different relative responses to interest rates under different regimes. Looking at monthly data since December 1994, Exhibit 4 shows that the S&P 500 rose about 66% of the time, while U.S. Treasury rates fell about 49% of the time (almost a coin flip). Current market expectations are of falling rates and a positive market environment, which happened one-third of the time. 2022’s dynamic of a falling stock market and rising rates was rare, occurring in 15% of months.

Exhibit 5 shows the historical relationships between interest rates and market regimes and the performance of various U.S. equity size ranges relative to the S&P 500. A key observation is that the direction of the stock market mattered more than the direction of interest rates in driving relative performance: the average relative performance changed by greater amounts based on market direction than on rate changes. Exhibit 5 also shows that the S&P MidCap 400, S&P SmallCap 600 and S&P 500 Equal Weight Index tended to outperform the S&P 500 in months when both the S&P 500 was up and U.S. 10-Year Treasury yields rose. The indices tended to perform in line with the S&P 500 when the large-cap U.S. equity bellwether gained and the U.S. 10-Year Treasury was down.

Of course, it is difficult to predict the direction of interest rates, the stock market, or both. But the historical performance of smaller U.S. size segments, their distinct characteristics and their sheer size mean that market participants may wish to consider the S&P 400 and S&P 600 as additional tools in their U.S. equity choices.

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Equities

Splitting Size in U.S. Equities: S&P DJI versus MSCI in H1 2023

The first half of 2023 saw a strong rebound from 2022 for equities: the S&P 500® gained 17% as the U.S. outperformed the S&P Global Ex-U.S. BMI (up 10%). Information Technology led the way across the U.S. cap spectrum, possibly reflecting investors’ expectations regarding the potential impact of artificial intelligence.

The S&P Composite 1500® combines the S&P 500, S&P MidCap 400® and S&P SmallCap 600®, representing the investable portion of the large-, mid- and small-cap U.S. equity market, respectively. While other index series like the MSCI USA Investable Market Index (IMI), Russell 3000 and CRSP US Total Market aim to measure the U.S. market, differences in index construction can lead to clear distinctions in size and composition, as illustrated by Exhibit 2.

S&P DJI U.S. Core Equity Indices underperformed their MSCI USA Index counterparts in H1 2023, typically driven by a lower exposure to Information Technology, which was the best performing sector. However, when looking at 20-year and nearly 30-year time horizons, S&P DJI U.S. Core Equity Indices typically outperformed in the long-term.

One relative bright spot for the S&P DJI U.S. Core Equities in H1 2023 was the S&P MidCap 400. Despite the S&P 400® having a lower exposure to Information Technology than MSCI USA Mid Cap of 5.4%, the S&P 400 outperformed by 2% in H1 2023, extending its 2022 outperformance of 5%. The S&P 400 also outperformed the S&P 500 Equal Weight Index by nearly 2%.

There are several potential candidates to explain the S&P 400’s relative performance versus the MSCI USA Mid Cap Index. For example, size, earnings screen and sector exposures. To better understand some of these factors, we conducted an analysis comparing the relative size, sector and stock selection effects between the two mid-cap indices.

Overall, the choice of companies within S&P 400 sectors mattered more than the sector and size exposures in isolation. When splitting our two universes into quintiles, Exhibit 4 shows that more than 50% of the MSCI USA Mid Cap Index belonged to the largest two size quintiles at the end of H1 2023. The total allocation effect in H1 2023 was negative. In contrast, the S&P MidCap 400 had more exposure to the smallest quintiles, with the selection effect in the Quintile 5 driving its outperformance in the first half 2023.

The choice of stocks explained 70% of the S&P 400’s relative outperformance. Exhibit 5 shows the Two-Factor Brinson Attribution of the S&P 400 against the MSCI USA Mid-Cap Index by GICS® Sector and analyzes how much of the S&P 400’s H1 2023 relative return can be explained by differences in sector exposures (allocation effect) versus the choice of constituents in each sector (the selection effect). When looking at sectors, a lower exposure to Information Technology detracted from performance, an overweight to Industrials was one component to outperformance in H1 2023, which rose 22% in H1 as shown in Exhibit 1. However, in several instances the allocation effect of sectors was neutral or negative (e.g., Financials), but a strong selection effect (choice of stocks) within sectors in those instances meant that the total effect was positive.

While both index series are designed to measure the performance of large, mid and small size segments and various combinations of the U.S. equity market, differences in defining the size split and index construction (such as the S&P Composite 1500’s earning screen) have historically resulted in contrasting size exposure, index characteristics and performance.

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Equities

Getting to Know the Dow Jones U.S. Select Insurance Index

The global insurance market capitalization has grown significantly over the past three decades, growing from nearly USD 350 billion at the end of 1992 to USD 2.7 trillion as of H1 2023. This growth was accompanied by a shift in global leadership. For example, Exhibit 1 shows that European insurance companies made up a greater proportion of the insurance market than their U.S. counterparts in the early 1990s. Nowadays, the U.S. accounts for the majority of the market capitalization, while Europe’s weight has diminished.

The Dow Jones U.S. Select Insurance Index captures an investable portion of the world’s largest insurance market. As with other indices in the Dow Jones U.S. Select Sector Speciality Index Series, the index is designed to measure the performance of selected subsectors of the Dow Jones Industry Classification System (DJICS). Constituents must also meet liquidity and market capitalization thresholds. The index uses a float-adjusted market capitalization (FMC) weighting scheme with some high-level diversification capping rules applied and is rebalanced quarterly in March, June, September, and December.1

The Dow Jones U.S. Select Insurance Index comprises stocks from the Dow Jones U.S. Broad Stock Market Index that are classified under DJICS as Full Line Insurance, Property & Casualty Insurance and Life Insurance, and excludes companies whose principal business activities are classified as Reinsurance and Insurance Brokers. Exhibit 2 shows that Property & Casualty Insurance is the primary subsector, making up 67% of the index as of June 30, 2023, followed by Life Insurance at 24% and Full Line Insurance as the smallest slice at just 10%.

Insurance companies are typically considered non-cyclical or “defensive” given that the products and services provided by insurance companies are often needed regardless of the phase of the business cycle. The historical performance of the Dow Jones U.S. Select Insurance Index appears to reflect this perspective.

Exhibit 3 shows that, while the Dow Jones U.S. Select Insurance Index posted similar performance to the Dow Jones U.S. Broad Market Index since the end of 1991 (an annualized 9.5% vs 9.9%, respectively), the insurance index outperformed in turbulent environments. For example, the broad market declined by 19% in 2022, while the Dow Jones U.S. Select Insurance Index gained 12%, outperforming by 31%. In H1 2023, the insurance index underperformed, as tech stocks propelled the market higher.

The Dow Jones U.S. Select Insurance Index typically had a lower trailing 12-month P/E ratio than the Dow Jones U.S. Broad Stock Market Index, meaning market participants typically paid less for every dollar of earnings received. The index also had a moderately higher realized dividend yield than the Dow Jones U.S. Broad Market Index, showing that insurance companies paid more dividends relative to their share price.

1 For further details, please see the Dow Jones U.S. Select Sector Speciality Indices Methodology.

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Equities

Connecting the S&P/ASX 200 to U.S. Equity Icons

Many market participants have a “home bias,” typically having larger exposures to domestic securities than would be determined by their representation in the global opportunity set. Australia is no exception: compared to Australia’s 2% weight in the S&P Global BMI, Australian investors allocated an estimated 49% of their total equity allocation to domestic stocks at the end of 2022.1

Exhibit 1 shows that Australia’s home bias—as measured by the difference between investors’ total domestic equity exposure and the country’s weight in the S&P Global BMI—is larger than several of its developed market peers, such as Canada, Japan and the U.K.

Such home bias means that investors have less exposure to the U.S. equity market, which makes up nearly 60% of the S&P Global BMI. The S&P Composite 1500® represents the investable portion of the U.S. equity market (~90%) by combining the large-cap S&P 500®, S&P MidCap 400® and the S&P SmallCap 600® and leaving out less liquid and lower quality stocks.

The U.S. is home to well-known global mega-cap names such as Apple and Microsoft, which may help to balance Australia’s overweight to Financials and Materials. Exhibit 2 shows that combining the U.S. and Australia’s equity benchmarks may help alleviate the domestic sector biases. Compared to the S&P Global BMI, the Australian bellwether underweights Information Technology by 18%, with I.T. being the S&P/ASX 200’s second-smallest sector, at 2%.

Potential diversification benefits could also have come in the form of improved risk/return profile. Exhibit 3 highlights that the S&P 500 outperformed the S&P/ASX 200 by 2% annualized since Dec. 30, 1994, in local currency and U.S. dollar terms. This makes the long-run outperformance of the S&P 400® and S&P 600® even more impressive; the non-perfect correlations of these indices versus the S&P 500 (shown in Exhibit 4) also means there is an opportunity for investors to diversify within their U.S. equity exposure as well to gain access to the unique characteristics of U.S. mid- and small-cap indices.

Exhibit 2 which shows that differences in sector composition may help explain the non-perfect correlation between the S&P/ASX 200 to our U.S. core equity indices, which ranges from 0.44-0.52 when looking at monthly returns in AUD terms, as illustrated in Exhibit 4. This moderate correlation suggests that combining the two sets of indices may lead to better risk-adjusted return than either one in isolation.

In Exhibit 5, we take the blue-chip benchmarks of both the U.S. and Australia and create hypothetical combinations of the S&P 500 and the S&P/ASX 200. We can see that adding the S&P 500 to the S&P/ASX 200 has historically improved return per unit of risk (risk-adjusted return) across all points on the efficient frontier over exposure to the S&P/ASX 200 alone.

While there are several reasons why Australian market participants may choose to have a home bias, in the past, U.S. equities helped investors diversify from sectoral home biases and historically improved domestic returns.

 

1 Thinking Ahead Institute, “GPAS 2023 Pensions Survey,” 2023.

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Equities

Potential Applications of U.S. Equities for Asia-Based Investors

Many investors have a so-called “home bias,” allocating to their domestic market in greater proportion than would be expected based on its representation in global equity markets. Asia-based investors are no exception. Here we present our U.S. equity icons as one potential way to provide diversification for Asian investors.

The breadth and depth of the U.S. equity market means that investors risk overlooking a significant chunk of the global equity opportunity set by under-allocating to U.S. equities, which may result in a large active share compared to a global benchmark. For example, Exhibit 1 shows that the U.S. was nearly three times larger than the entire investable Asian equity market, with smaller U.S. equity segments as large as entire local stock markets. The S&P 500® makes up nearly half of the pie, with the S&P MidCap 400®  and SmallCap 600® being larger than the Australian and Hong Kong stock markets, respectively.

Beyond U.S. equities representing a significant portion of the global opportunity set, their distinct sector weights may help investors to overcome domestic sector biases. Exhibit 2 shows GICS® sector weights of the S&P Pan Asia BMI and the relative weight compared to the S&P Global BMI and the S&P 500. The S&P Pan Asia BMI’s largest weights are in Financials (17%) and Information Technology (16%), with its smallest weight in the Energy sector, at 3%. Some key differences between the S&P Pan Asia BMI and S&P Global BMI and S&P 500 are that the global and U.S. benchmarks have a larger weight in Health Care and Information Technology and lower weights in Consumer Discretionary, Materials and Industrials.

The performance of U.S. equities may also motivate some to consider incorporating U.S. equities alongside domestic equities. Exhibit 3 shows the cumulative performance, in USD terms, of the S&P Pan Asia BMI versus U.S. equity indices since Dec. 30, 1994. The right-hand bar chart shows the annualized total returns of various single stock market indices against the S&P 500, S&P MidCap 400, S&P SmallCap 600 and DJIA®. Quite clearly, the U.S. equity indices outperformed, historically.

Exhibit 4 shows that the outperformance of U.S. equities was not driven by currency effects. Indeed, the S&P 500 outperformed single-market indices (as represented by the S&P Global BMI sub-indices) in local currency terms as well.

Exhibit 5a also shows the potential diversification benefit of incorporating U.S. equities: there was a non-perfect correlation with Asian equities over the last 28 years. Exhibit 5b also highlights that several single-market indices rank significantly lower in terms of correlation, with China having a 0.4 correlation to the U.S. since Dec. 30, 1994.

Unsurprisingly, perhaps, incorporating allocations to the S&P 500 could have improved risk-adjusted returns. For example, Exhibit 6 shows the annualized returns and volatility for various hypothetical combinations of the S&P 500 and the S&P Pan Asia BMI. These hypothetical combinations rebalance back to the target weights at each year end.

Portfolios that included some proportion of the S&P 500 posted higher returns than a 100% allocation to the S&P Pan Asia BMI.  The high returns were also achieved at a lower annualized risk.

Check out more research and insights on the S&P 500 and DJIA at https://www.spglobal.com/spdji/en/education/article/comparing-iconic-indices-the-sp-500-and-djia/ and https://www.spglobal.com/spdji/en/education/article/regional-relevancy-of-sp-500-and-dow-jones-industrial-average-futures-in-asia.

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Equities

An Israeli Home with a U.S. Twist

Our new research paper shows that Israeli investors have a greater home bias than other nations: they have invested more heavily in domestic equities and allocated to the U.S. in lower proportions than their developed markets peers such as the U.K., Europe and Canada. With U.S. equities making up nearly 60% of the S&P Global BMI’s market capitalization, such allocations may be overlooking a sizeable portion of the global equity opportunity set. Adding some U.S. decor to a domestic Israeli equity allocation also historically provided higher return in both absolute and risk-adjusted terms, and could offer the potential for diversification.

U.S. Equities Have Outperformed Their Israeli Counterparts over Various Horizons

The S&P 500®, S&P MidCap 400® and S&P SmallCap 600® outperformed the Israeli equity market—as represented by the TA-125—by 15%, 11% and 9%, respectively, in Q1 2023 (all in ILS and total return terms). Exhibit 1 shows that this phenomenon is not just a recent one: U.S. equities have outperformed their Israeli counterparts over short-, medium- and long-term horizons in both absolute and risk-adjusted terms. Similar results are observed for USD-denominated versions of the indices.

Looking at the correlation of U.S. equities with the TA-125 and blue-chip TA-35 in Exhibit 2 we can see that all of the S&P Composite 1500®’s component indices had a correlation of less than 0.5 (based on monthly returns since Dec. 31, 1994). This suggests an opportunity for U.S. equities to act as a diversifier when incorporated into Israeli equity allocations.

Despite recent spikes in 3-year rolling correlation, compared to correlations over the last 28 years, U.S. and Israeli equities are not perfectly correlated (equal to 1), which means there is still opportunity for diversification. In recent times, that opportunity has increased, with U.S. and Israeli equities continuing to decouple from their 2020 coronavirus correlation highs.

The outperformance of U.S. equities, and their lower long-run correlations with Israeli equities since December 1994, has meant that adding U.S. equities to an Israeli equity allocation could have improved returns, with lower volatility. Exhibit 4a shows the annualized return and volatility figures for various hypothetical combinations of the S&P 500, S&P MidCap 400 and S&P SmallCap 600 with the TA-125, starting with a 100% Israeli allocation and moving in 10% increments to a 100% U.S. equity allocation. Each hypothetical portfolio rebalances back to the target weights at the end of each quarter.

In addition to the potential performance and diversification benefits, incorporating U.S. equities may help Israeli investors to alleviate domestic sector biases. Compared to the S&P 500, Israeli equity indices like the TA-125 and TA-35 are heavily overweight Financials and Real Estate, while underweighting Information Technology by 11%, as shown in Exhibit 4b. The S&P 500’s largest constituents include some of the world’s most well-known “big tech” companies, such as Apple and Microsoft.

While U.S. equities are not the only way to seek diversification, investors may wish to evaluate their U.S. equity exposure in order to avoid overlooking a sizeable portion of the global opportunity set. A simple flourish of U.S. equities may not be enough to decorate a home, and so one may want to consider a real twist to measure the full potential of U.S. equities across capitalization ranges, especially as smaller U.S. equity segments are as large as other countries’ stock markets.

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Equities

What’s in a U.S. Equity Index?

2022 was the worst year for U.S. equity indices since 2008’s Global Financial Crisis, with the S&P 500® entering a bear market and declining 18% in 2022. Despite the market blues, there were some relative winners: the S&P DJI U.S. Core Indices beat their MSCI counterparts last year, driven by differences in their methodologies. Below we examine the impact of index construction on performance, factor exposure and sector weights of the two index series.

Exhibit 1 highlights that the S&P Composite 1500®’s outperformance was both consistent and widespread in 2022, with S&P DJI U.S. Core Indices outperforming MSCI ACWI USA Indexes across all market capitalization segments on average for three out of every four months in 2022. The outperformance ranged from 1% to 5%, with mid caps hosting the biggest performance differential—the S&P MidCap 400® beat the MSCI USA Mid Cap by 5%, its largest calendar year margin since 2016. Since Dec. 31, 1994, S&P DJI U.S. Core Indices beat MSCI ACWI Index in most cap-ranges.

Differences in index construction have meant that S&P DJI indices have historically had a higher exposure to the quality factor than their MSCI counterparts. For example, the S&P Composite 1500 requires, among other criteria, potential new index additions to have four consecutive quarters of positive earnings to be considered for eligibility. The MSCI ACWI USA Indexes have no such requirements. This difference helps to explain why S&P DJI indices have a significant exposure to the quality factor, as shown in Exhibit 2.

Quality was a big differentiator in mid and small caps, with the widest spread between S&P DJI and MSCI quality scores in these size ranges. This difference is particularly acute in mid and small caps because firms are at an earlier stage in their lifecycle than large caps. It is typically harder for firms to reach the capitalization of “large caps” without being profitable. The S&P Composite 1500 filters out lower quality stocks which has given the S&P SmallCap 600 and S&P MidCap 400 a quality premium compared to the MSCI USA SmallCap and MSCI USA MidCap, respectively. A robust earning screen has helped S&P DJI U.S. Core Indices outperform when quality is in favor and “junk” falls out of favor.

Sectors were also a major driver of performance in 2022, as the spread between best- and worst-performing sectors in the S&P 500 closed the year at 106%. The S&P 500 and S&P MidCap 400 both had a lower sector weight to Communication Services and Information Technology than their MSCI counterparts, explaining part of the recent outperformance given the material underperformance of technology-related sectors. The S&P 500 and MSCI USA Large Cap had a 26% and 28% weight to Information Technology, respectively. While I.T.’s mid-cap sector weight is about half of its large-cap weight, the spread in its weighting between benchmarks can vary more, with the MSCI USA Mid Cap having a 4% overweight versus the S&P MidCap 400, as shown in Exhibit 3.

While indices designed to measure the performance of U.S. equity market may look similar on the surface, especially in the short run, when you look more closely, differences in index construction can have a significant influence on performance, factor exposure and sector weights. It’s important to remember that it is often in the long run when quality shines through.

For more on index construction, visit https://www.indexologyblog.com/tag/index-construction/.

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S&P 500 & DJIA

Balancing the Scales in U.K. Equity with the S&P 500

Our recent paper Why Does the S&P 500® Matter to the U.K.? argues that the S&P 500 presents an opportunity for U.K. investors to diversify their revenue exposure and sector weights across geographies. Since British investors typically suffer from a substantial home bias, such diversification presents an opportunity to improve the risk/return profile of a domestic equity allocation.

Both U.K. companies and U.K. investors are exposed to the same set of domestic macroeconomic conditions. When a large proportion of a company’s revenue is reliant on its domestic customer base and an investor in turn overweights his allocation to U.K. equity, it creates a domestic feedback loop. This means that positive and negative shocks in the U.K. are amplified for a local investor who is not properly diversified.

Moreover, the U.K. has more significant over- and underweights than the S&P 500 relative to a global benchmark. Exhibit 1 compares the sector weights of the S&P 500 and S&P United Kingdom versus the S&P Global 1200. The S&P United Kingdom had larger sector weights than the S&P Global 1200 in Consumer Staples, Energy and Materials, and a far lower weight in Information Technology. On the other hand, the S&P 500 was overweight IT and Communication Services. Hence, incorporating U.S. equities could help a U.K. investor alleviate domestic sector biases by providing exposure to different sectors.

From a performance perspective, U.S. large caps have outperformed their U.K. counterparts most of the time and by a larger magnitude when they do. Over the past 33 calendar years, the S&P 500 has outperformed the S&P United Kingdom two-thirds of the time, as shown in Exhibit 2. In the years when the S&P 500 outperformed it did so by a higher margin on average, at 9.9%, compared to the U.K.’s 8%. This has meant combining the S&P 500 and the S&P United Kingdom (as shown in Exhibit 3) has historically improved the risk/return profile and provided a higher return per unit of risk than a U.K. investment in isolation.

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Equities Factors

When the Winds Change

“Change is the investor’s only certainty.”

Thomas Rowe Price, Jr.

2022 marked several major changes in market trends amid a substantial shift in global macroeconomic regimes. After historic levels of stimulus, multi-decade highs in inflation across several major economies led to monetary tightening. This shift weighed on asset classes in many regions, and traditional routes of diversification proved problematic as bonds and equities fell in tandem. In U.S. equities, growth, mega-cap and “big tech”, dominance gave way to a resurgence in value, as well as outperformance from smaller companies and Energy. Exhibit 1 summarizes the changing trends observed in 2022 in sharp contrast to 2020 and since the start of the 2010s, by showing the excess returns of various indices versus the S&P 500®.

The S&P 500 Pure Value was one of the few indices to remain near flat in 2022, falling 1% compared to the S&P 500’s 18% decline. The S&P 500 Value and S&P 500 Equal Weight Index also outperformed by 13% and 7%, respectively. Exhibit 2 shows the consistent outperformance of these indices throughout 2022. All three indices benefited from their greater exposure to value-oriented companies last year, as growth-oriented companies came under particular pressure amid interest rate hikes.

Growth has had a symbiotic relationship with the Communication Services, Consumer Discretionary and Information Technology sectors. Unsurprisingly, growth’s underperformance had a particularly large impact on these sectors, as they declined 40%, 37% and 28%, respectively. On the opposite side of the sector spectrum, the S&P 500 Energy led the way as it gained 66% on the back of higher oil prices. Energy’s momentum contributed to the widest spread (best minus worst) in calendar year sector returns on record (see Exhibit 3).

2022 reminds us that change is a constant of life. Being equipped with a full range of index-based tools can help market participants manage within different market regimes.

Categories
Equities S&P 500 & DJIA

Do Friendly Bears Exist?

“Never sell the bear’s skin before one has killed the beast.”

Jean de La Fontaine.

On Wall Street, bear markets represent declines of at least 20% from their highs. But on Main Street, bears are anthropomorphized as friendly. Here we look at whether bears can also be “friendly” in financial markets, looking at the S&P 500®’s bear markets to assess what periods of pessimism have told us, historically, and whether there may be glimmers of hope.

A tumultuous 2022 resulted in the S&P 500 entering a bear market and posting its worst calendar year performance since 2008, down 18%, bringing an end to its three-year winning streak. The picture could have been grimmer had it not been for an early rally  in October and November; the S&P 500 was down more than 25% at its worst point.  Exhibit 1 shows that the S&P 500’s reached only one all-time high during 2022 (on Jan. 3), the fewest all-time highs in a year since 2012.

Investors may be forgiven for forgetting what it feels like to be in a bear market. The S&P 500’s longest bull market, which began after 2008’s Global Financial Crisis (GFC), was followed by the shortest bear market in history. Exhibit 3 shows that the current 2022-23 bear market’s 20% decline hasn’t reached the same magnitude as the 2020 COVID-19 sell-off or 2008 GFC, which recorded declines of 34% and 57%, respectively. However, 2022’s bear market is already 11 times the length of 2020’s COVID correction.

Overall, the S&P 500’s 14 bear markets since 1928 lasted an average of 19 months and were accompanied by an average peak-to-trough performance of -38% (see Exhibit 3).

However, market participants can take one silver lining from history—the S&P 500 has typically rebounded from major drops over medium horizons. For example, Exhibit 4 shows that the S&P 500 gained an average of 15% over the three-year period following the beginning of a bear market, and the index typically exhibited a positive return. While history shows the importance of treading with caution in bear markets, a friendly reminder is that at the end of every bear market, a bull market begins and all things pass in time.