Indexes Change Over Time. Recent Data Is More Important Than Long-Term Data. It just is.

Jan 18, 2018 in Regime Change | S&P 500

An index can change rather importantly over time.  Some segments go through sustained secular performance and become increasingly important on a secular basis.   This has happened with the internet relative to much older industries.  Sometimes it can be a bubble but for every time someone calls something irrational, there are many cases where something secular is happening.

Below is a chart plotting how much more important Amazon.com is to the performance of the S&P 500 than it used to be.  This has come at the expense of names like Exxon. 

Another example is Facebook vs Chevron.

 

To look at a different part of the world, think about how important China Mobile used to be vs where it is now and how Alibaba Group was 0% and now its the 2nd largest holding in the S&P China Index.

 

Think about what this does to fundamental ratios like P/E's and dividend yields on the index aggregates.  Exxon pays a large dividend -- AMZN and FB don't pay anything in dividends.   Exxons P/E in 2007 was under 13x while the AMZN P/E has averaged well into the triple digits over the past 10 years.

This is loosely related to 'Regime Change' -- the fundamentals of backtesting are that you should think about RECENT DATA and weight it more heavily than old data.    Same concept.  What the P/E was 10 years ago isn't very important  And what it was 30 years ago is less important than that. We do NOT mean to imply 'this time is different'. We are simply saying weight more recent times more highly than you do data from 100 years ago.   

See also:

Regime Change Backtesting

 

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Holding Vanguard S&P 500 While Paying a 2% Fee

Dec 08, 2017 in S&P 500

 Example of what fees did to the decade of the 2000s.    Dec 31, 1999 to Dec 31, 2009.

 

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What was the S&P 500 Total Return for 2014?

Jan 04, 2015 in S&P 500 | Total Return

Total return measures capital appreciation AND the return associated with dividends (and any other distributions -- such as capital gains distributions). It is always surprising how many emails we receive saying our numbers are incorrect because people compare one price to another price. That is INCORRECT. The correct TOTAL RETURN for 2014 for SPY was +13.5%, not 11%. Total return in 2014 was +2.3% higher than the price return. (There is no actual such thing as a 'price-only S&P' -- the S&P index price only exists as an index, NOT as an investable fund -- nobody would be so stupid as to buy a fund that doesn't pay out its earned dividends). For ETF's with higher yields -- (and/or for those with cap gains distributions) -- this difference will obviously be higher.

Over a few years, this difference really adds up to be a VERY substantial amount.

 

 

 

 

 

 

Click for link to free Total Return vs Price Return Page

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SPY S&P 500 Index Total Return For 2013

Jan 01, 2014 in S&P 500 | Total Return

 

Total return measures capital appreciation AND the return associated with dividends (and any other distributions -- such as capital gains distributions).     It is always surprising how many emails we receive saying our numbers are incorrect because people compare the year-end SPY price to the previous year-end. That is INCORRECT. The correct TOTAL RETURN for 2013 for SPY was +32.3%.    That is +2.6% higher than the price return.   For ETF's with higher yields -- (and/or for those with cap gains distributions) -- this difference will be higher.   

Over a few years, this difference really adds up to be a substantial amount.   

 

 

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S&P 500 Consensus EPS As Of Aug 9 vs Same Point Prior Years

Aug 09, 2013 in Earnings | S&P 500

 

Growth for S&P 500 index earnings has been a little north of 6% on a Compounded Annual Growth Rate (CAGR) basis since 1999.

 

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S&P 500 Total Return For 2013

Jul 19, 2013 in S&P 500 | Total Return

People seem to get confused by this so let's just update the Total Return for 2013 here and explain a few things.  Below is a chart of our Free Total Return vs Price Return webpage with the same security below from a leading institutional platform.   The numbers are the same.  One of the key benefits of having an exchange is the data comes from the exchanges, not some proprietary source (which is unlike the bond 'market' -- where there is no exchange).

 

 

 

A few comments:

First,  an index does not have shareholders.   Indexes are uninvestable --- what you are investing in (be it an index mutual fund or an ETF) is a financial PRODUCT that tracks (or attempts to track) an index.

Since an index does not own any shares of the companies in the index,  companies in the index do not owe the index any cash like a regular shareholder is entitled (dividends).   This creates a difference in those securities that are investable (ETFs) and those securities that are not (indexes that aren't total return).

Now, you can buy options and futures based on an INDEX --- but those are derivatives and thereby do not need underlying securities.   It should be pointed out that ETFs are not derivatives any more than a mutual fund is a derivative.   In fact, most ETFs are registered under the very same 1940 Securities & Exchange Commision (SEC) act as mutual funds.   The basic structure is the same --- though the mechanics are different.

Some people mistakenly think that since when you buy an ETF and you are therefore getting ETF shares, that represents a derivative.  It most certainly does not.   When you buy a piece of property, you get a deed (a legal contract).   When you buy a stock, you get a stock certificate.   When you buy a mutual fund you get mutual fund shares.    These are not derivatives.   The vital difference is that derivatives do not hold the underlying securities ----  ETFs DO hold the underlying securities, which makes them regular pooled investment funds.

Now, since ETFs hold various numbers of shares, they are paid cash when companies make those distribution payments (dividends) to shareholders. It is important that you account for these distributions as when you go to rank securities,  the entire ranking process will be compromised unless you are using the same process across all securities in the list.    In fact, one error in a list of securities can impact the entire rank order and actually affect the chosen securities to be included in a backtest,  meaning you cannot have ANY errors.   

Since ETFreplay covers nearly 1000 securities, we took great care in building our processes -- and importantly, how you cross-check data.   Good thing for us is that modern databases (such as the most recently released SQL database our service provider runs on) were architected precisely to address the inherent problems in data management.    (databases have very rigid rules relative to something like a spreadsheet, which was created for the masses).  

As a sidenote, because it is frankly amazing ---- the use of Excel has been the source of two very high-profile finance-related errors in the past year ---  the London Whale incident at JP Morgan --- as well as the influential Reinhart-Rogoff economic paper used to justify the adoption of Austerity.    We maybe are less surprised that academics would makes  such an error --- but the JP Morgan case is amazing because of the mere fact that they would ever run such massive amounts of money without a more architecturally secure product than Excel.    Did nobody in the JP Morgan london office ever study the benefits of using a relational database management system (RDBMS)?    Running a database enables many levels of cross-checks and reporting that is impossible in a spreadsheet.   Caveat emptor. 

See Also:  Other Total Return Blog Posts

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S&P 500 Index Earnings Relationship to S&P 500 Is Not Straightforward

Jan 03, 2013 in Earnings | S&P 500

As we head to earnings season, let's look at what has happened in past years EPS progression for the S&P 500.   We have indexed everything to begin on Sep 30 of each year and show the change coming from that starting point.

 

2009 was a massive outlier so we excluded it ---- earnings estimates totally collapsed that year in delayed fashion to the 2008 financial crisis.  Stocks that year of course cratered from January to March and then turned hard and  ended 2009 with a very big up year.    A financial crisis of that magnitude isn't going to happen again anytime soon and it is certainly nothing like the set-up we have coming into 2013.   Someday maybe again -- and if it does begin tracking that during the next few months, we will be sure to let you know. :)

The point of the above is to show that the relationship between earnings and the stock market should not be taken so confidently.    Said another way,  the volatility of the P/E multiple dwarfs changes in actual fundamentals (as defined by something like index earnings estimates).    Whenever you have something very volatile, it will be hard to make precise sense of it from a pure fundamental basis.    Fundamentals are important --- but there are good reasons why the market is much more volatile than underlying earnings and this has to due to so many other factors --- including behavioral issues dealing with confidence, fear, greed,  missing out etc...

Here is a snapshot of S&P 500 and 2012 earnings overlaid on the same chart to see what happend in the most recent year relative to what are now historical earnings.

 

 

 

 

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S&P 500 Total Return For 2012: 16%

Jan 02, 2013 in S&P 500 | Total Return

There is always confusion over this so we'll just answer it here rather than responding to a lot of emails.

The S&P 500 is a total return index  (all indexes are total return indexes).  If you want to refer to the S&P 500 without dividends --- you call this the 'S&P Cash Index' (or just 'price return') --- that is not the S&P 500 though.    SPY is the ETF version of the S&P 500 index and varies very slightly due to the nuances of an actual traded investment product on a public excange that you trade during open market hours vs an index value that is determined based on official closing prices and isn't finalized until after the close.

You don't have to take our word for it though, this is from Standard and Poors itself (we continually run reports to check our returns vs key sources, we take data integrity seriously):

 

We have a free page so that you can understand ETF distributions as many charting services have architectural issues with displaying this correctly.    Note that the vast majority of technical services were built for short-term traders, not investment managers.   Dividends might not seem important to you -- but 2-3% a year compounds into a big number over a lifetime of investing.   Moreover, there are many ETFs that pay much higher than 3% -- you need to compare investments based on the total return series.

Total Return vs Price Return Free Page

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Taking A Simplistic High-Level Look at S&P 500 Earnings

Dec 10, 2012 in Earnings | S&P 500

The S&P 500 is expected to earn about $110-$112 in earnings in CY 2013.   With the S&P 500 cash index closing at 1,418 yesterday, the P/E is 12.7x.

In January, you can be sure to hear a lot about earnings and speculation on what will happen to that ~$111 figure.   It is probably too high given that is the norm.  That is,  estimates usually start high and then move down somewhat throughout the year.   That has not been bearish in the past -- that is the normal 'expected' result (there are many, many examples of the market doing well as earnings dropped). What is significant is if it falls sharply -- or rises even modestly-- those are not normal.

Recessions cause S&P earnings to drop sharply so that is of course the ultimate in concerns.   What is always interesting is for an earnings report from XYZ company to come out and then various commentators will try to extrapolate a forthcoming big disaster for the economy based on that result.   Those people have been consistently run over in this bull market.  

With that all in mind, here are some high level numbers to help keep it in perspective -- just the S&P 500 companies alone are projected right now to do about $1.04 trillion in net income (with a 't').   So that means that each $1 in S&P index earnings per share is about $9.3 billion in actual after-tax income dollars.   Next time you hear about some company that is going to drive the economy off a cliff, think about that statistic.   Is it so bad as to take -$93 billion off S&P aggregate earnings --- if it is, then that will cost the S&P -$10 of its ~$111.

Taken a step further, a recession might cause EPS to drop back well below $100. But to get from $112.00 down to say $90.00 (a -$22 per share) --- that works out to be about ~$202 billion less in net income.

That is quite a drop.   Wal-mart is projected to do about $18 billion in 2013 so we need the equivalent of 11 Wal-Marts to all simultaneously become profitless.  

We will have another profit downturn someday because we will have another recession someday -- but that is about all you can say as there is nothing right now that would indicate this is happening.  Indeed, financial sector earnings have actually increased over the last 90 days -- led by Bank of America, a company expected to do $11 billion of earnings in 2013 -- which is still down by about 50% vs expectations ~5 years ago.   Yes, tech earnings have weakened and energy has had a very poor earnings year -- so of course we will continue to pay attention to those developing situations.

Then again, you don't need any of that to happen just to have a market correction.   Be diligent and manage risk of course --- but keep this all in mind next time you hear how Caterpillar is taking its profit estimate down by $300 million for 2013 --- which is not even the equivalent of a nickel of the ~$111.00 S&P index earnings per share.   For S&P earnings to drop real materially,  you need a major sector to pretty much implode (like Tech in 2001 and Financials in 2008) ---  and then for a real doozie of a drawdown, you need the problem child sector to also drag others down with them into the abyss.   That is what causes the largest market drawdowns. 

 

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S&P 500 Weightings 2006 vs 2012

Apr 26, 2012 in S&P 500

Quick look at how S&P 500 Weightings have changed.   Apple is a massive change obviously.   

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