Indexology^® Blog

Water is one of the world’s most essential commodities, but it is at risk from overuse, pollution, and soaring demand. S&P DJI’s Tianyin Cheng joins Redsand Ventures’ Colleen Becker to explore new tools for understanding and accessing water assets.

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Indian capital markets had an exceptional year in 2020. The COVID-19 pandemic initially had an adverse impact on Indian capital markets, as indices across size and sectors fell during the period from February 2020 to May 2020. However, from June 2020 onward, all size and sector indices had a bull run through the end of the year. The S&P BSE SENSEX TR increased from 60,211.40 on Dec. 31, 2019, to 70,543.23 on Dec. 31, 2020—a one-year absolute return of 16.31%.

Exhibit 1 and 2 showcase returns for India’s leading size indices in 2020.

From Exhibits 1 and 2, we can see that all five size indices performed well, and returns were promising for large-, mid-, and small-cap segments. The returns of the small-cap and mid-cap segments were better than those of the large-cap segment. The S&P BSE SmallCap and S&P BSE MidCap posted one-year absolute returns of 33.53% and 21.31%, respectively, while the S&P BSE LargeCap and S&P BSE SENSEX returned 16.31% and 17.16%, respectively.

Exhibits 3 and 4 showcase returns for the 11 leading sector indices for India in 2020.

In Exhibits 3 and 4, we can see that most of the sector indices posted promising returns in 2020. The S&P BSE Healthcare and S&P BSE Information Technology performed exceptionally in 2020, with absolute returns of 62.61% and 60.05%, respectively. The S&P BSE Finance and S&P BSE Utilities were the worst-performing indices in 2020, with absolute returns of 1.25% and 4.18%, respectively.

To summarize, we can say that except for the couple of months at the beginning of the COVID-19 pandemic, the bulls had their way in 2020, and indices across size, segments, and sectors gave promising returns in 2020.

2020 was a year of two reversals for the market. First, equities recovered from the depths of March to finish the year strongly, and second, smaller-cap and value stocks staged a roaring comeback in the final quarter.

We can better understand the second reversal by analyzing the market’s distribution of returns and the performance of stocks relative to the index as a whole. Exhibit 1 illustrates this for the S&P 500^® for the past 20 years. Of the 980 stocks that were in the index during this period, only 211, or 22%, outperformed. When only 22% of the stocks beat the market, stock picking is hard, underscoring the persistent underperformance of most active managers.

Exhibit 1 summarized 20 years of data, but we also see the challenges of stock selection in most individual years, and 2020 was no exception. Exhibit 2 shows that the S&P 500’s return for 2020 (18.4%) was much higher than the median stock’s return of 8%. The outperformance of large-cap stocks meant that only 34% of stocks beat the index.

However, the path for stock-pickers was not a straight one in 2020. Exhibit 3 shows that from Q1 through Q3, the S&P 500 posted a return of 5.6%, as mega-caps outperformed during the period. As a result, only 35% of stocks were able to outperform the index.

In contrast, in Q4, the market reversed course, where the S&P 500’s return of 12.2% was much below the median of 17.1%, signaling the recovery of smaller-cap stocks. Therefore, 60% of stocks were able to outperform the index, almost double what we saw in the first three quarters.

This analysis has interesting implications for active management: The dominance of mega-caps hindered stock selection from Q1 through Q3. Meanwhile, in Q4, the comeback of smaller caps lowered the threshold for success, leading to a greater hit rate of outperforming the index. It is not solely the distribution of returns, but the return distribution across the cap range that matters.

As most active portfolios are closer to equal than cap weighted, it is also important to remember that smaller-cap outperformance favors equal-weight indices, which led to S&P 500 Equal Weight’s recent reversal. If the trends from Q4 continue, we can anticipate a more favorable environment for active managers. Whether they will be able to take advantage of it remains to be seen.

One of the major trends in the last few years has been the outperformance of large, growth-oriented stocks and, at first glance, 2020 represented a continuation of this trend. For example, the S&P 500^® Growth (33.5%) outperformed the S&P 500 Value (1.4%) by 32.1% last year, the largest difference in calendar year total returns between the two indices, ever.

However, focusing on the overall picture for 2020 ignores a recent reversal in fortunes—Value outperformed Growth by 3.8% between the end of September and latest annual S&P U.S. Style Indices reconstitution (Dec. 18, 2020), contributing to Value’s second-largest quarterly outperformance since 2009 (Value beat Growth by 6.9% in Q4 2016).

Much of the outperformance in Q4 2020 can be attributed to the beginning of the COVID-19 vaccine rollout, which fueled expectations of an economic recovery and lifted many value-oriented stocks that were particularly impacted by the COVID-19 correction. Overall, S&P 500 Value constituents posted higher returns than their Growth counterparts in 7 of the 11 GICS^® sectors leading up to the December 2020 style reconstitution.

More recently, Value has outperformed by around 2% since the results from the latest reconstitution went into effect (prior to the open on Dec. 21, 2020). Value-oriented Financials provided tailwinds, lifted by increased investor speculation that interest rates will rise in 2021 in response to higher U.S. inflation expectations.

While it remains to be seen which news stories will dominate headlines this year, georevenue exposure may offer insights into the relative fortunes of Value and Growth. For example, Exhibit 3 shows that value-oriented companies are typically more domestically focused than their growth counterparts: the sales-weighted average U.S. revenue exposure is greater for many sectors in the Value index compared to the Growth index. This suggests that news that causes investors to change their U.S. economic outlook and/or expectations for domestic consumers’ spending—such as the vaccine rollout late last year—may have an outsized impact on Value’s returns. Similarly, Growth’s fortunes may be more sensitive to global narratives, especially as they relate to some of the largest market constituents.

As a result, the recent reversal in Value’s fortunes has led some investors and commentators to suggest that we may be witnessing a long-anticipated rotation away from Growth and into Value. Although we shall see whether there is growth in value or value in growth, differences in georevenue exposure may be a useful way to understand movements across style indices.

For many equity investors, the stand-out theme of last year was the reversal in the market’s initial response to, and recovery from, the COVID-19 pandemic: the dramatic price declines in March, the wild swings around the bottom as VIX^® marked its highest closing level ever, and the just-as-dramatic recovery to new all-time highs by late summer. That reversal set the big picture: after its recovery and barring a few small bumps along the road, the S&P 500^® continued to break records for the remainder of the year, celebrating with a final closing record high on Dec. 31, 2020.

The full-year performance of the S&P 500 sectors and factors highlighted in Exhibit 1 seem to conform to a single narrative: large, tech-related, growth companies benefited from the changing circumstances of the pandemic, while smaller companies, and energy and value companies in particular, continued their multi-year trend for underperformance.

Yet, another major reversal may also have occurred.  Less obvious but with the potential to be just as significant, this was more keenly felt in relative (as opposed to absolute) returns. It was visible in cracks in the once seemingly unstoppable momentum of large, tech-related growth companies, the poster companies of which are now the S&P 500’s largest weights. Apple, Microsoft, Alphabet, Facebook, Amazon and (now) Tesla stand at the nexus of several multi-year trends: larger stocks outperforming smaller, growth stocks outperforming value, and less flashy sectors, like energy and materials, underperforming the average.

Exhibit 2 suggests that there have been not one but two reversals this year in the S&P 500’s factor and sector winds: one in the late spring that ended in the late summer and accompanied the market’s recovery from the depths, and a further, visually more significant reversal in the trends that occurred in the final quarter. Intriguingly, this continued into the new year; the data included in the chart run up to the most recent close at time of writing, Jan. 6, 2021.

A return to winning form for value and small-cap stocks has long been anticipated; these strategies, thanks in part to their canonical status as original Fama-French factors and long performance record, have attracted a broad range of followers. The decline of the Energy sector—once more than 16% of the S&P 500 by weight, and now only 2% (see Exhibit 3)—has been a similarly long-term and connected source of disappointment for investors.

As we pointed out in our recently published S&P 500 Factor Dashboard, the challenges to continued outperformance from large-cap growth, driven by Big Tech or otherwise, are different to what they were a year ago. To outperform next year, the capitalization-weighted S&P 500 Growth may have to rely on an unusually narrow range of companies: the index’s largest five weights composed 40% of the total index by the end of last year, the highest ever annual reading. If those large names at the top falter, value’s time to shine may be finally upon us.