In this edition we have a Goldman Sachs strategist, of all people, refuting some negative myths about passive investing and its effects on equity markets. Also, an analyst finds 45 million barrels of oil, I unveil my favourite fictional president and we look ahead to upcoming economic data.
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Passive vs. active
Index investors not distorting the market says Goldman Sachs
Goldman Sachs chief U.S. equity strategist David Kostin might be motivated to poke holes in passive investing - active investing is more profitable for his employer - but instead he took the opposite approach in his Weekly Kickstart report. Mr. Kostin refuted the most common arguments against passive investing.
The strategist first noted the remarkable growth of passive investing before assessing whether it’s distorting the equity market. In the United States, US$2.8-trillion has been invested in passive funds in the past decade while US$3.0-trillion has been removed from active funds.
Passive investing is often blamed for high degrees of correlation between S&P 500 stocks – all stocks moving in the same proportions because of inflows into passive funds. Goldman Sachs, however, notes that correlation has declined in the past ten years while passive investing began to dominate.
Variation in valuations is also not affected by index investors. Mr. Kostin found that company fundamentals explain roughly 50 per cent of the differences in valuation between stocks. Including the extent of passive fund ownership for each stock, however, was not associated with valuation differences.
The argument that passive investing artificially boosts returns for stocks that dominate the index was also found unable to hold water. For one, there is an inverse relationship between market cap and passive ownership. (He notes that on a market-cap weighted basis, passive ownership across the Magnificent 7 stocks, which are all within the top 10 largest stocks in the S&P 500, currently stands at 22 per cent vs. 25 per cent for the remaining 493 stocks in the index.) For another, stocks with high degrees of passive fund ownership have not consistently outperformed.
There is no reputable study in finance showing that active investors outperform passive investors over time – index investing is simply the smartest thing to do. I have quibbles, but they are minor. One is that I don’t fully trust high yield bond ETFs to handle liquidity concerns during a sustained sell-off.
Another is that I don’t love sector ETFs. They will probably perform better than picking individual stocks in that sector, but that misses the point. The advantage of passive investing investing is diversification - owning the entire index to capture whatever type of performance leadership occurs.
Mr. Kostin’s report is yet another reason to avoid active investing and just buy broad indices – the S&P/TSX Composite and the S&P 500 – which is why I suggest it to anyone who asks me how to start investing.
Energy
The unknowability of oil fundamentals
There is a decent sized group of oil investors who believe that any decline in the crude price is irrefutable proof of a conspiracy. This is perfectly understandable in an industry in which accurate fundamental data is often a misnomer.
A story last week from the Financial Times’ Alphaville site called JPMorgan discovers 45 million barrels of oil emphasized the problem. The story recounts that China’s use of underground storage and OPEC’s iffy level of transparency on production make it very difficult to assess current supply. The end result is that “Forecasting future supply and demand in the current environment is a waste of time because we cannot even measure what’s happening in the present,” said a former president of Koch Global Partners, a large-scale investor in oil.
The headline refers to three J.P. Morgan analysts predicting a big oil deficit in June. The analysts were forced to backtrack and admit the shortfall was 45 million barrels below their initial assumptions.
Actor Jeff Bridges poses for a portrait in Beverly Hills, Calif. on Tuesday, Feb. 2, 2010.Matt Sayles/The Associated Press
Diversions
The best fictional president ever
The Contender, starring Joan Allen, Gary Oldman, Jeff Bridges and Sam Elliott, is not a very good movie. The political fight for a female vice president was valid and important for a year 2000 movie but the way the plot is executed stretches our collective gullibility too far.
The reason I’m bringing up a movie I didn’t like much this week is that Jeff Bridges almost rescues the entire operation with my favourite portrayal of a U.S. president ever. President Jackson Evans is folksy, subtle, sly, funny, manipulative, principled and altogether riveting to watch.
The big speech at the end of the movie might be known to many movie watchers but it borders on hackneyed for me. That said, it’s entirely worth it to skip through the movie and watch Mr. Bridges cook throughout the whole film.
The essentials
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Globe Investor highlights
Ian McGugan wonders why investors so far appear so complacent about the U.S. election. Further to that topic, Tom Bradley makes the argument that the U.S. election isn’t a risk to your portfolio.
Rob Carrick ponders the question, are TD shares a good landing spot for maturing GIC money?
Tim Shufelt takes a look at why crude prices remain lacklustre despite all the turmoil in the Middle East and Ukraine.
What’s up next
The big economic report domestically is net change in employment for October but we’ll have to wait until Friday for that. A gain of 39,000 jobs is expected. The unemployment rate is forecast at 6.5 per cent.
The only other data point of note domestically is the S&P Global Canada Services PMI for October on Tuesday.
For earnings, Brookfield Asset Management Ltd. earnings were released Monday pre-market and the stock was up a buoyant 7 per cent at midday. Sun-Life Financial was scheduled to report after the close Monday, and analysts were looking for $1.69 per share.
Manulife Financial Corp. reports Wednesday with $0.937 per share forecasted. BCE Inc. ($0.77), Cameco Corp. ($0.236) and Barrick Gold Corp. ($0.308) all report on Thursday.
U.S. factory orders for September were released Monday morning, falling by 0.5 per cent month over month, close to economists’ expectations.
ISM services PMI for October is expected to remain in expansionary territory at 53.5 when reported on Tuesday. The Fed Open Market Committee will release its decision on rates on Wednesday and a cut of 25 basis points is widely expected.
The U.S. earnings calendar features high-flying Constellation Energy Corp. (an 11-cent beat) on Monday, Emerson Electric Co. (US$1.458) on Tuesday, QUALCOMM (US$2.559) on Wednesday and robotics provider Rockwell Automation Inc. (US$2.359) on Thursday.
See our full economic and earnings calendar here (You can bookmark the page - it gets updated weekly)