Monthly Brief September 2018 – Know Your Index

Monthly Brief September 2018 – Know Your Index

 

CAPITAL MARKETS
By reputation, September and October are known as months during which US equity markets tend to struggle. But the S&P 500 Index did not fit this pattern during September 2018, finishing modestly higher. Not only were broad measures of US large-cap stocks higher, but the widely used measure of equity volatility, the VIX Index, actually declined during September. These two outcomes were certainly contrary to popular expectations for the month, particularly with the ten-year US Treasury Note moving higher above 3% while the Federal Reserve instituted another rate hike.

The trend higher also extended across international developed markets as the MSCI EAFE Index advanced during the month. But, while this welcome result set the tone for equity markets, not all participated as broad measures of US small-cap stocks and emerging markets finished September lower.

This has set the stage for the fourth quarter of 2018 with earnings, interest rates and politics all in focus. Can corporate earnings maintain their momentum? Are interest rates signaling more economic strength, or raising a flag of caution? And politics…

While earnings will likely reflect healthy growth, a slowing in the rate of growth might be viewed as a cautionary signal. Could a move higher in interest rates be signaling continued economic growth? Or interpreted as restrictive to further gains? Would lower interest rates suggest tempered expectations? As this data becomes available, investors’ conclusions regarding these inflection points will likely serve as primary catalysts for the next phase within the global capital markets.

CHART OF INTEREST – KNOW YOUR INDEX
This past month saw US equity markets defy September’s reputation as one of the most seasonally-unfavorable times of the year. Not only did large-cap stocks move higher, a number of indexes also made new all-time highs. And September capped the best quarter for the S&P 500 Index since Q4 2013.

But an index is a basket of securities and, more important than the index performance, is how the securities within the index have performed. Each index has a defined method of construction. For example, the S&P 500 Index weights stocks within the index by their market capitalization, i.e., the sum total of the value of each company’s shares outstanding. Using this
methodology, the ten largest stocks within the 500+ stocks that make up the index account for over 20% of the index’s calculations. Interestingly, while the S&P 500 Index made a new high, these stocks collectively were slightly down during September.

While this may sound confusing, a more curious case is the stalwart Dow Jones Industrial Average. This index is price weighted, meaning Boeing (at $371/share) has a larger impact on the index than Apple (at $225/share), despite being 1/5 of the market capitalization of Apple. And approximately half of the Dow Jones Industrial Average’s gain in 2018 has come from just these two stocks.

Finally, some popular indexes are heavily weighted towards a specific part of the market. For example, approximately ¾ of the NASDAQ 100 Index is held in the Technology, Consumer Discretionary and Communication Services sectors, while these sectors make up only approximately 40% of the S&P 500 Index.

All this is not to say that these popular gauges of the broad US stock market are flawed. But, rather, these details emphasize the importance of understanding the message that each particular index is telling us. Healthy markets can exist without milestone moments and new records do not always mean all is well. It’s important to know your index!

James Ferrin, CFA
Chief Investment Officer

 

Quantitative Advantage, LLC (QA) is an investment advisor registered with the Securities and Exchange Commission and is a limited liability company organized in the state of Minnesota. Registration of an investment advisor does not imply any specific level of skill or training. QA Wealth Management is a division of QA.

This information has been prepared by QA, is provided for informational purposes only and does not constitute investment advice. It contains general information, is not suitable for everyone and is subject to change without notice. The views and opinions expressed in this report are solely those of QA and are current as of the date of writing. While the content is provided in good faith to provide a general commentary of current market factors and conditions, the views and opinions expressed are limited in scope and QA makes no representation or warranty as to the accuracy or completeness of the information provided. Past performance of the global investment markets is not a guarantee of future results.

The index performance results referenced in this report represent past performance and are not a guarantee of future performance. Investment returns and principal value will fluctuate and are subject to market volatility, so that a client’s investment, when sold, may be worth more or less than the original cost. Indices are unmanaged and investors cannot invest directly in an index. An index’s performance does not reflect the deduction of transaction costs, management fees, or other costs which would reduce returns.

The S&P 500 Index is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the New York Stock Exchange or the NASDAQ Stock Market.

The Dow Jones Industrial Average is a price-weighted average of 30 U.S. blue-chip companies. The index covers all industries except transportation and utilities.

The NASDAQ 100 Index includes 100 of the largest domestic and i nternational non-financial companies listed on the NASDAQ Stock Market based on market capitalization.

For additional information regarding these indices, please refer to the sponsor websites at www.standardandpoors.com, www.spindices.com and www.nasdaq.com.

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