Two topics today, one long and one short:
Topic #1: The equal weight S&P 500 index is an often-mentioned foil to the more commonly cited market cap weighted index, meant to show how the “real” market is doing. This is an appealing shortcut, since it does wash out Big Tech’s impact on performance and (in theory) reveals how the typical US large cap stock is doing. For example:
- The market cap weighted S&P is trouncing the equal weight version of the index YTD, -5.1% versus -10.8% …
- … But the equal weight S&P is up more since the March lows, +44.3% versus +37.1% for the market cap weighted index …
- … And over the last year the market cap weighted S&P is solidly ahead of the equal weight index, +6.2% versus -2.2%.
The most common explanation for these variations is how super cap (usually Tech) names are faring versus the rest of the market, but the reality is that the equal weight S&P is a very different animal from the more common form of the index. Here’s why:
#1: Sector weights:
- Some variations are what you’d expect: Tech is 12.2 points less of the S&P 500 equal-weight (14.3% vs. 26.5%) and Communication Services is 6.4 fewer points (10.9% vs. 4.5%).
- But then there are some surprising ones:
Industrials are 14.8% of the equal weight S&P but just 8.1% of the market cap weighted version (6.7 points difference, more than what Google and Facebook’s reweighting does to shift equal/market cap weightings).
Energy is 6.0% of the equal weight S&P but only 3.0% of the market cap weighted index. That 3-point difference is more important than having Visa be 0.2% of the equal weight portfolio rather than 1.3% of the market cap weighted version.
Financials are 13.4% of the equal weight S&P but 10.6% of the market cap weighted index and Health Care is 11.2% of the equal weight portfolio but 14.4% of the market cap weighted one. That’s another 6 points of variance between the two indices.
#2: Investment style:
- The market cap weighted S&P is 68% growth stocks, 19% value, and 13% blend/other.
- The even weighted S&P is 48% growth stocks, 29% value, and 23% blend/other.
Summing up: the equal weight S&P 500 index is not really comparable to the market cap weighted version since it has noticeable sector and style tilts.
Topic #2: We always tell you to trust Fed Funds Futures to give you an edge in predicting future policy decisions, and a new paper by 2 MIT economists explains why this works.
First, here is a nifty chart from the paper (“Monetary Policy with Opinionated Markets”) that shows our point about Futures getting rate policy more correct than the Fed itself (or any Wall Street firm that leans on the “Dot Plot” too hard):
The solid lines (Futures) are always more accurate than the Fed’s own predictions, but why? According to the paper’s authors (Caballero and Simsek), it comes down to:
- A difference of opinion about future aggregate demand, and…
- … “Moreover, these disagreements shape optimal monetary policy, especially when they are entrenched. The market perceives monetary policy “mistakes” and the Fed partially accommodates the market’s view to mitigate the financial market fallout from perceived “mistakes.”
Summary: This theory makes sense to us, even if it is remarkable to see an academic paper say that the Fed doesn’t want to disappointment markets and therefore alters policy to please them.
MIT Paper ($5 to purchase): https://www.nber.org/papers/w27313