How many active funds beat the SP 500 over the past 8 years?

4   

That's out of more than 7,000 mutual funds.

Remind me again why anyone uses active management?


Source:  http://thereformedbroker.com/2015/05/12/how-many-active-mutual-funds-have-beaten-the-sp-500-in-8-consecutive-years/

How generous are the top 50 S&P 500 companies' 401K plans

There's a big difference across plans, and it has nothing to do with investment options.   As usual, the details are in the fine print.

Lobbying pays

Stocks in the "lobbying index" significantly outperform the S&P 500.

HT: Ron.

More on volatility and the level of the market

John Cochrane (aka the Grumpy Economist) talks about volatility and the level of the market.  I blogged on this recently here.

John takes things a bit further and throws a little math at the problem.  He has some interesting analysis, although he concludes that our current state of asset pricing is able to fully account for the effect (in some many words).

The VIX is low...

This is relevant to my MBA students who currently have an assignment on implied volatility:

The VIX has declined steadily over the past few months, and at the same time, stocks have rebounded.  

From the graph it appears that the VIX is quite negatively correlated with the S&P 500.  Something that is pointed out here and here.  

I decided to grab some data from yahoo finance and look at the correlations.  First of all if you just look at the raw correlation of the VIX and the S&P 500 from 1990 you get a small positive correlation of about 0.14.  However, if you look at the daily change in the VIX and the change in the level of the index, the correlation is -0.57.  That's a pretty large negative correlation.   

What is unclear, of course, is what is causing what?  Is higher volatility hurting prices or is that falling prices increases volatility?  An obvious thing to look at is the correlation between the prior day change in the VIX and the current day change in the index.  Not surprisingly, this correlation is close to zero indicating that there isn't a simple trading rule.  (If there was, do you think I'd blog it?)

Still, the VIX is a pretty interesting index.

The Dow is a horribly constructed index

Another nice post from Kid Dynamite.  This time having a go at the Dow Jones Average.   If you don't know why the S&P 500 is fundamentally different from the Dow 30 (apart from the little matter of 470 stocks), then you need to read this.

SPY and GLD correlations and volatility.

Apparently the value of the GLD ETF (an Exchange Traded Fund that holds gold) has exceeded the value of the SPY ETF (which holds stocks from the S&P 500).  All this gold is held in bank vaults in London (which in light of recent riots may not be that sensible).  The total amount of gold held by the fund in these vaults is about 41. 5 million ounces, which is about 1300 tons.  That seems like a lot of gold.

In the article, a hedge fund manager was quoted as saying that
“Gold has become something of a near-perfect hedge for financial assets such as stocks,”
This got me thinking - I wonder what the correlation between GLD and SPY is?

Here are the daily correlations.  Note that GLD has been trading since 2004.
2004-2011: 0.0506
2008-2011: 0.0108
2010: 0.1961
2011: -0.2655

First of all we can see that over the long run, there has only been a weak correlation between GLD and SPY.  In 2010 however this correlation became positive and quite strongly so.   But for the first half of 2011 we can see a strong negative correlation.  While not a "near perfect" hedge, it certainly looks like GLD is moving against stocks.  The problem of course is predicting how long this movement will continue and at what point in time (if ever) the old pattern of a small positive correlation will reassert itself.

Looking at daily annualized standard deviations, (assuming 250 trading days) we see that GLD is a little less volatile that SPY.

2004-2011
SPY Std Dev:  22.6%
GLD Std Dev: 21.0%

2011
SPY Std Dev. 20.00%
GLD Std Dev. 15.24%

Surprisingly SPY is not as volatile as you might think - perhaps a classic case of investors anchoring their beliefs too much on recent market gyrations.

While I don't make prognostications, it does seem likely that a large amount of the demand for GLD may be coming from people moving money out of stocks.  If this is the case, then if and when the stock market starts to rebound, we should see a pretty rapid fall in the price of gold.

Big stocks in the S&P 500

From my colleague, Craig Newmark, 10 stocks account for 1/5 of the S&P 500's market cap. This is actually the reason why the Dow 30 (30 stocks) does a pretty good job of tracking the much broader S&P 500.  Of course, in recent weeks, the Dow hasn't done so well.

Dow vs S&P 500

Considering that the Dow contains only 30 stocks and is a bizarre price weighted index, it does a surprisingly good job of tracking the S&P500.  That is unless if you don't consider the past month or so.  Turns out that the Dow has been lagging the S&P 500 by quite a margin.
Felix Salmon has the details

The importance of the VIX

Nice article about the VIX.  (The S&P 500 volatility index).

HT: Mike (one of my MBA students).

The AP doesn't know what a value weighted index is.

I've pretty much come to the conclusion that most journalists who write about finance don't really know much about finance.  That's because they have degrees in journalism, so they know lots about ... (I'll figure that bit out later).

Anyhow, consider this gem from the AP.

As soon as the total value of the company's shares edges above Exxon's, Apple will take over the top spot in the Standard and Poor's 500, the market index used by most professional money managers.

That means that billions of dollars invested in funds that track the index will have to shift their holdings to reflect Apple's new weighting. Exxon, meanwhile, may see its share price fall from the same effect. That slide could be accelerated by hedge funds and technical traders who make bets based on the rebalancing of major indexes and would be primed to short the shares of Exxon.

This is, of course, completely and utterly untrue.  The S&P 500 is a value weighted index.  If you hold the stocks in it, their weights in your portfolio will adjust at exactly the same rate as the weights in the index.  That's the beauty of a value weighted approach.


Note to finance students.  Don't believe all that you read on the interwebs.


Note to would be finance journalists:  Take some finance classes.




HT: Felix.

S&P at your finger tips

Political calculations has two excellent calculators online that show the performance of the S&P 500 over different time periods and also the amount you'd make by investing in the index over different time periods. Excellent stuff.

HT: FinanceProfessor.

How accurate is the Dow?

The Dow Jones Industrial average has been reworked again to reflect the bankruptcy of GM. Both the Dow and the S&P 500 are periodically changed when something happens to one of their constituents. The selection process for the new stocks that are added to the indices is a bit of a black box, but one thing appears to be true - both indices may inadvertently engage in a buy high sell low strategy. In effect the stocks that are deleted are ones that have been beaten down, while the stocks that are added are often stars in their sector. Evidence for this is explained here in a nice article on seeking alpha

I blogged about this before, and more I think about it, I think there must be a market for a pure buy and hold mutual fund.

Put options as portfolio insurance

A recent article on the WSJ site advocates the use of put options as portfolio insurance. The article is correct in that put options are a way of insuring your portfolio, but the basic premise that this insurance is getting cheaper is flawed. The author points to the fact that December puts on the S&P 500 with a strike of 600 have been falling in price as the market has risen. What a surprise! Options 101 will tell you that the value of a put moves in the opposite direction to value of the underlying asset. To suggest that these are "cheaper" is just silly. They are cheaper because, in effect, the amount of insurance that you are getting is declining as the index rises.

S & P earnings...Fama and French comment

This issue keeps coming back like a bad penny. The issue of how S&P computes earnings ratios. My last post on it was here.

Fama and French have weighed in and argued that they use the method used by S&P, which in "normal" circumstances probably makes sense. But I disagree with them on this comment...

It is easy to see the logic if you imagine merging all of the firms into one giant conglomerate. The new firm's earnings and market equity are just the sum of the individual firms' earnings and market equity.

The S&P 500 is not a giant conglomerate. If a massive firm goes bankrupt and posts massive losses that outweigh it's market value, those losses are not absorbed by the other firms in the index as in a conglomerate. Once the firm has zero value, that's it. The losses are then absorbed by the creditors.

How Dow Jones and SP mess things up

A student of mine sent me this link in which it is argued that changing the composition of the Dow (or SP 500), causes these indices to underperform a fixed basket of stocks.

The components of both indices change when a stock drops out and is replaced by a new stock and the new addition is invariably some hot growth stock that has seen a rapid run up (i.e. MSFT, GOOG, Yahoo etc) and the stock that is dropped out (particularly in the Dow) is a value stock. So, in effect, the indices buy growth stocks when their values are high.

Indexing is great because it reduces the cost of active management. But as this article shows, there is still the active management of the index creator that can mess things up for you.

Searching for value

The Economist has a stab at trying to determine if the market is cheap yet. The conclusion, cheaper yes, dirt cheap - perhaps not.

S&P Earnings are too low

Edited post...
On Feb 25, I originally posted the following (I subsequently withdrew the post to think about it more):

"The Wall Street Journal has an Op-ed piece by Jeremy Siegel who argues that earnings reported for the S&P 500 are understated because of the goofy way that S&P computes the index's aggregate earnings.

Whereas the returns on the S&P 500 are estimated on a value weighted basis, S&P estimates aggregate earnings by merely adding up the earnings of all the stocks in the index. Of course stocks that are loosing lots of money tend to have low values. So the earnings number for the index is artificially reduced by this approach. This means that a) S&P 500 earnings aren't as bad as they look, and b) the P/E ratio for the S&P 500 is actually much lower than reported."

Since posting this a commenter noted that I had it wrong. Also several blogs [here, here and here] had come to the same conclusion that indeed Siegel had messed up.

Their logic is simple - the S&P 500 is a value weighted index. The value of the index is basically all the market values added up (and adjusted for float - although that's not important here) and then divided by a fixed divisor.

Therefore a PE ratio of the index = [Sum of market values/divisor] / [Sum of earnings/divisor]

Obviously the divisor cancels and you are left with the sum of market values divided by the sum of earnings, which is what S&P does and what Siegel argued was wrong.

After thinking about it more, I think that Siegel is correct, although his point is perhaps not very well made.

Consider a simple value weighted index with two stocks:
A has 1000 shares and a price of 20, and a market value of 20,000.

B has 1000 shares and a price of 0.05, and market value of 50.

A is 99.751% of the index, B is 0.249% of the index.

B used to be a big company, but now isn't! (Think Citigroup).

A has net income of 2000, B has net income of -1000.

Using S&P's method the PE of the index is (20,000+50)/(2000-1000) = 20.05

Using Siegel's method the PE of the index is (20,000*.99751+50*.249)/(2000*.99751-1000*.249) = 10.013


OK, so what's going on here? It is quite unusual to have very low market cap firms loosing huge amounts of money, but with the financials in the S&P 500, that is what we are seeing now. If you bought the S&P 500 today, you are basically buying stock A, and a tiny stock called B which has a very bad history. But the bulk of your holdings come from stock A. Sure B has lost money, but if the losses exceed the market value, these aren't losses that you as a stock holder will bear. In fact the most you can loose now on your investment in B is 50. The losses are what got the stock down to this point. B has become trivial to your portfolio, you basically own A, and any decision to buy more of this portfolio should be based on whether you think A is fairly valued. I'd argue that assigning a PE of around 10 is far more realistic than A PE of 20. If the PE is a forward looking measure, then forward looking, your future contains mostly stock A, and hardly any B.

Another way of looking at this is that when a stock is close to zero, it is an option. You don't suffer the downside, you only get the upside. Therefore creating a PE that incorporates this huge downside is going to result in a PE that is too high.

This other blogger also thinks Siegel is correct

Bad news in the charts

My colleague Don sent me this picture. As all chartists know, you should sell when you see the black swan indicator.

How good are analysts?

The Investor Insight website has an interesting study that shows that analyst earnings forecasts basically lag the actual forecasts.

This chart is particularly interesting:



Basically it shows that analysts change their earnings forecasts after the market has started deviating from the trend.

As a side note, the weekly newsletter from John Maudlin (from this site) is excellent.