Second Quarter Preserves First Quarter Market Gains: We're Still Above Water and Treading
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Be on your guard against a silent dog and still water.
Stock markets delivered positive returns for the first six months of 2011, albeit all of it in the first four months. May and June took back all of the gains from April, leaving only the gains earned in the first quarter. Value investing has dominated markets across the globe, reflecting caution, since the concept of “value” is “safe.” Importantly, the definition of “value” has become very important and index providers disagree – many distressed banks are value in the Russell and S&P indexes but they are growth in my Surz indexes. Surprisingly, financial stocks in the US have suffered this year, while foreign financials have done just fine. Sector allocation decisions should differentiate between foreign and domestic. Are foreign financials in better shape than US financials?
By contrast health care stocks around the globe have led the markets, possibly playing on the aging population theme. Japan and emerging markets have lost value. Japan’s problems stem from their tsunami and nuclear disasters. The emerging markets setback follows a two-year run that doubled the value of these stocks, so valuations were running high but now they have retreated and are once again below market averages. The Price/Earnings ratio for emerging markets is currently 15.5, which is below the current average for all foreign stocks of 17.
Let’s look at how the US market performed and then how foreign markets fared. I’ll conclude on a lighter note with a couple of videos that address key topics in the investment arena.
The year-to-date in review
I examined the performance of the S&P500 and EAFE indexes using attribution analysis described at StokTrib. You should perform similar analyses on your own portfolios to know why you are succeeding or failing, so you can adjust accordingly.
US stock market
I begin with an analysis of the style composition and performance of the S&P500 as shown in the next exhibit. A quick explanation of this graphic is available at Performance.
The portfolio in the exhibit is the S&P500 index and the benchmark is the entire U.S. stock market. Let’s begin with a discussion of the style make-up of the S&P as shown in the bottom of the graph. Unsurprisingly, the S&P has a large-company orientation, tilted toward large-value companies. The total market is about 30% large-cap value, whereas the S&P is 40% large-cap value.
This large-value orientation helped the S&P (relative to the total market) because value companies performed better in the year-to-date, as shown by the fact that the middles of the floating bars for large-and mid-value are above those of the other styles. These floating bars represent pure scientific peer groups, as described at Portfolio Opportunity Distributions (PODs). The median of each POD is the return for that style in aggregate and the ranges (spread from top to bottom) of each bar are the return opportunities for that style. Note for example the very wide range of opportunities in small-cap growth because this is not a homogeneous group of securities. Also, as you can see, large-value companies returned 6.75%, while mid-value returned even more, earning 9.97%. By contrast, large core and large growth lagged with 3.6% and 2.1% returns respectively. So the offsetting effects of large value versus large growth caused the S&P’s 6% return to be in line with the total market’s 5.7% return.
The other component of attribution is stock selection, which we can see as the location of the dots in the exhibit. For the most part, the stocks selected by the S&P committee performed near their respective medians within each style.
You can use this exhibit to rank individual managers within styles, as well as rank their style components. Just plot your dots in the graph above. For example, locate your manager’s style in the exhibit (large value, small growth, etc.), and place his rate-of-return within the corresponding floating bar, using the scale on the left and the median from the table above as your guide. Voila, an accurate ranking.