People obsess over what the major stock market indices are doing daily. In nearly a decade in this business I’ve had my share of phone calls from clients concerned about what the S&P 500 or the Dow Jones Industrial Average is doing on a given day. Clients should feel free to call me when they have concerns. I’m happy to give answers. But, I also want my clients to understand that day to day market movement is not what moves me, and it shouldn’t move them either. What an index does on any given day absolutely does not matter to me, and it shouldn’t matter to my clients. It may matter to institutional traders or to the day trading club that hangs out at the local watering hole.
Indices only matter to me over longer time periods. I use longer range data from indices for the tactical asset allocation models and for the Beanstalk, which is a stock-only growth at a reasonable price quantitative screen. I also use various indices to benchmark overall performance–to make sure that my models are keeping pace and are where they should be. For example, I’ve had clients call me to discuss market returns for the first four months of this year–which are astronomical–in relation to their own model allocations which are geared completely differently. By differently, I mean that these models sometimes contain considerably less stocks in order to suit what’s appropriate for a client’s age, risk tolerance, goals, and other factors. The S&P 500 and the Dow Jones Industrial Average are 100% stock. So, comparing them to one’s own model that might hold only 60% stock, for example, is not comparing apples to apples. Clients are sometimes surprised in meetings when I bring out the most current Morningstar index sheet. I’ll use it to show them an index created by Morningstar that tracks the performance of a risk-tolerance based asset allocation model instead of using the S&P 500 Index. Once I explain why I’m using that as my benchmark, it makes perfect sense to them.
There’s more to the discussion. Today was the perfect day for me to capture this in action. I noticed that my overall assets under management were down a bit today and that the overall stock market was too, as of 12:45-ish this afternoon. I assumed my clients in stock models would be the ones showing losses for the first part of the day. However, when I looked at my accounts, I realized that my clients in my stock models were actually positive for the day and my clients in asset allocation models, or the income and growth oriented Cruiser model, were the ones showing losses for the day. Many times the inverse happens: the stock market indices can be positive during the day, and the stock models can be negative.
I don’t usually insert disclaimers or caveats into the middle of my blog posts, but I am today. I’m about to show the current companies in the Beanstalk. This is not a recommendation to buy or sell any of these companies. This screen runs every month and I’m certain that at least two of these are going to be removed when it gets updated next week. These stocks have all entered the screen on varying dates. 100% stock portfolios are not appropriate for the majority of my clients, and you should not make purchases without consulting an advisor. So, call me or your advisor to discuss if you are interested.
Back to the discussion. Here’s what the stock market, as shown by the most popular indices, was doing at 12:46 pm today:
You can see that the market was in negative territory at that time. So, I also tossed the ticker symbols from the Beanstalk into a quick portfolio to see what was up and what was down that was causing clients with the model to be positive while the market was down. Here’s what I got:
The model has enough upside in some of its holdings to be positive when the markets are negative, though this doesn’t happen every day. By looking at this I can tell that companies in the sectors of insurance, healthcare, retail, and tech are having a pretty good day. I can also tell that consumer staples and energy are having a generally bad day. How can I tell? Because I know the sectors of each of these companies. So, I can check the news and see what’s pulling some down and what’s lifting others up.
At the moment, the S&P 500 as a whole is up about 25% from the bottom near the end of December. However, a full one-quarter of the companies in the index are still in the red 20% or more and have not recovered since the December decline (Source: CNBC). So, that means a few are hoisting the overall index. This also has to do with the fact that the S&P 500 is market cap weighted, meaning the biggest companies make up larger proportions of the index. The Beanstalk is a screen that runs against the S&P 500 like a sieve, pulling out only the ones I really want to buy. By looking at cost basis for my clients, I can see that 24% of the companies in the Beanstalk are still down 20% or more from the December decline. This is in line with expectations based on the performance of the stocks in the index.
One of the biggest differences between the Beanstalk and the S&P 500 over shorter time periods, such as a month, a quarter, or even half a year, is that the Beanstalk is equal-weighted. This means that, unlike the companies being market cap weighted in the S&P 500, all of the companies in the Beanstalk are given exactly the same proportion, regardless of size. About one-fourth of the S&P 500 is made up of just 15 or so companies out of over 500 (Source: S&P Global) because they’re huge.
Another difference is composition. Obviously 25 stocks is less than 500, but also some sectors don’t make the cut to be included in the Beanstalk. It never buys utilities, for example. Other groups can be overpriced. They’ll eventually rotate back in on their own. The Beanstalk is currently only 16% technology, while the S&P 500 recently has had 21% to 25% technology stocks. On the flip side of that, the Beanstalk has 24% allocated to Energy because . . . the sector is cheap and that’s part of the model’s value component kicking in, whereas the S&P 500 only has about 5% allocated to Energy stocks (Source: S&P Global).
My performance isn’t going to be perfect all the time, but no one’s is. As John Reese mentioned in Episode 93 of the Meb Faber Show, “There is no strategy that outperformed the stock market every single year.” That’s part of why advisors and their clients should meet annually to reassess what’s best for the client, and why advisors should review their strategies across the board on a regular basis. Even Warren Buffett regularly sets the expectation with investors that he’s not going to have the same performance going forward, or that he’s going to change evaluation methods. He’s in it for the long term. He talks about these expectations in his annual shareholder letters, and has been discussing this topic since the 1960s outside of the shareholder letter.
The bottom line is that performance of our own models should be measured by much longer yardsticks, even measuring within a year is short. Indices serve a purpose for benchmarking, but are not the only indicator that a model is performing, or that it’s suited to the client. The more important benchmark is THE CLIENT. Is the model properly diversified to help the client meet his or her goals? What are its risk metrics and are they in line with the client’s profile? In the end, we should be investing in what’s appropriate for us individually, and we shouldn’t be gambling, chasing returns, day trading, or worried about what an index is doing on a daily basis.
