1:51 – It looks like the market has been in a slump recently. Should we be concerned?
S&P 500
Mullooly Asset Show Episode 7
1:25 – The Big Short
4:18 – 2015 the Seinfeld year
6:48 – How to save $20,000
Is the S&P 500 a Good Portfolio Benchmark?
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This morning at our daily research meeting, we discussed something that several clients have brought up to us recently: it’s June and the Dow Jones Industrial Average and S&P 500 are barely positive for the year. While it is important to monitor your portfolio’s progress over time, many investors make the mistake of comparing their entire portfolio to these widely recognized market indices. The S&P 500 (and Dow Jones Industrial Average) do not make good portfolio benchmarks for most investors.
We often have to remind investors (and ourselves) that the S&P 500 is simply a basket of 500 US large cap stocks. Likewise, the Dow Jones Industrial Average is a group of 30 US large cap stocks. We sometimes forget this because these two indices are frequently referred to as “the market”. Neither of them are, in fact, “the market” and it’s not even close!
Unless your entire portfolio is invested in US large cap stocks, the S&P 500 is not a good portfolio benchmark. If you’ve diversified your US equity exposure to include mid and small cap stocks, you need a new benchmark. If your portfolio includes international equities, bonds, or commodities, you need a new benchmark.
A really simple way to get a more accurate reading of your portfolio’s performance is to create a better benchmark. Financial professionals like to discuss things like Sharpe Ratios when given this task, and that’s great if you’re a professional or have a strong interest in finance. For the average investor, there are simpler ways to measure your portfolio’s performance though. While no measure is perfect, the following would be an improvement over simply using the S&P 500’s return. During our research meeting today, Tim mentioned using the S&P 1500 as your US equity benchmark instead of just the S&P 500. That would certainly be a step in the right direction for most people. You could even take things a step further by weighting the returns of the S&P 500, S&P 400, and S&P 600 to mirror your portfolio’s weightings. For example:
If your US equity allocation is 25% large cap, 25% mid cap, and 50% small cap, you could take 25% of the S&P 500’s return, 25% of the S&P 400’s return, and 50% of the S&P 600’s return to get a much more accurate picture of how your investments have been performing.
You could do the same to create more accurate benchmarks for the international equity and fixed income allocations in your portfolio as well. Again, these aren’t perfect benchmarks either, but I believe they’re less flawed than measuring your entire portfolio against the S&P 500.
It’s also important to remember that measuring performance over short time periods (like months or quarters) might frustrate you. No strategy works 100% of the time. Ben Carlson put it nicely, explaining that, “Nothing works all the time. The reason most investment strategies work over the long-term is because they don’t always work over the short-term.”
While some people might think of the S&P 500 as “the market”, we wouldn’t recommend using it as a total portfolio benchmark.
Point and Figure Update: March 23, 2015
We have two quick updates on the S&P 500 and NASDAQ Composite indices today. Both are sending encouraging signals on their point and figure charts. They seem to be setting up for one of two potential patterns: the bullish catapult or the shakeout. Both the bullish catapult and shakeout are very bullish patterns.
Of course, we don’t know if these patterns will come to fruition, but they are something we’ll be monitoring closely in the coming weeks. A key with point and figure is to not anticipate signals or indicators, so while we are encouraged by these developments, things can change. Luckily, point and figure charts let us know what is happening in real time, as things pertain to the markets. We’ll be ready to adapt when the charts change.
Check out the point and figure charts of the S&P 500 and NASDAQ below for details. As always, our point and figure charts are provided by our friends at Dorsey Wright and Associates.
Relative Strength and the S&P 500
Keeping the theme with our podcast from last week (take a listen here if you haven’t already), Tom talks about the S&P 500’s two different forms. Many people don’t know that the S&P 500 is a cap weighted index, meaning the stocks with the largest market capitalization receive the highest weighting. There’s also an equal weighted version of the same 500 stocks, aptly named the equal weighted S&P 500. As you might be able to guess, the equal weighted S&P 500 pays no attention to market capitalization.
Our friends at Dorsey Wright and Associates shared some very interesting data with us recently that we wanted to pass along to you. Tom covers that data in the video. We can utilize relative strength (read more about relative strength here) to see which version of the S&P 500 is in favor at any given time. This is one of many tools we use to manage the risk for our clients here at Mullooly Asset Management.
Equal Weighted S&P 500 vs Cap Weighted
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It may or may not surprise you to hear that since January 1, 2000 the S&P 500 is up 24.59%. However, we bet you’re absolutely surprised to hear that during the same time period the equal weighted S&P 500 is up 152.86%. These numbers come to us courtesy of our good friends at Dorsey Wright and Associates. The variance in returns seen here lies in the composition of these indexes. Tom and Brendan discuss the differences between the S&P 500 and its equal weighted counterpart on this week’s Mullooly Asset Management podcast.
The S&P 500 that we hear about in the news every day is a cap weighted index. Out of the 500 stocks that make up the index, the ones with the largest market capitalization are responsible for most of the return. In fact, the top 50% of the S&P 500 (250 stocks of 500) controls 80% of the index’s return. To put it plainly, when the big stocks move the index as a whole tends to go with it.
In contrast, the equal weighted S&P 500 gives all 500 stocks the same weighting. Every stock represents 1/500th of the equal weighted S&P 500’s movement. This means that even the stock with the 499th largest market cap has a say in what the index is doing. The equal weighted S&P 500 is influenced by the trends of small and mid cap stocks much more than the regular cap weighted S&P 500. According to Dorsey Wright and Associates data, that exposure has been useful over the past 13+ years now.
Now this week’s podcast is NOT a way of us saying that the equal weighted S&P 500 will ALWAYS be superior to the cap weighted S&P 500. Nothing lasts forever! It is interesting to note its marked out-performance of the cap weighted S&P over the time period discussed though.
Make sure to listen to the podcast to hear the full discussion on the cap weighted and equal weighted S&P 500, and always consult your personal investment advisor before making any investment related decisions.
Again, all of the market data used for this week’s podcast and post was provided to us by our good friends at Dorsey Wright and Associates. Check out their site, you can learn a ton from these guys.
