Indexology^® Blog

Global equities witnessed a strong Q4 2023 as slowing inflation and the potential for lower interest rates improved market sentiment drastically. The S&P Global BMI rallied 11.4% for the quarter, finishing the year with an impressive 21.9% return. Middle East and North Africa (MENA) equities rose 6.4% in Q4, as measured by the S&P Pan Arab Composite, adding to a 10.1% total return for the year. Gulf Cooperation Council (GCC) countries largely posted gains, led by Bahrain (23.4%) and Saudi Arabia (15.0%), while Kuwait was an exception, with a 6.3% loss.

Shariah-compliant benchmarks, including the S&P Global BMI Shariah and Dow Jones Islamic Market (DJIM) World Index, beat their conventional counterparts by about 0.5% during the quarter, extending their outperformance to over 5% for the year and 19.7% cumulative over the past five years. Largely driven by its outperformance in the U.S., the benchmark DJIM Developed Markets Index stood out for relative performance against the conventional benchmark in 2023. The DJIM World Emerging Markets Index was a laggard, trailing behind the conventional benchmark as well as the developed market counterpart (see Exhibit 1).

Drivers of Shariah Index Performance in 2023

The outperformance of Shariah benchmarks against their conventional counterparts often comes into focus through the lens of sectors. Across global stock markets overall, a higher exposure to Information Technology stocks within Islamic indices, no exposure to conventional Financials (including banks) and less exposure to highly indebted companies (such as utilities) were the major drivers of the performance variance last year.

The Information Technology sector’s 53% gain played a major part in 2023, contributing to more than half of the S&P Global BMI Shariah’s total return. Energy, Utilities and Consumer Staples were the only sectors with losses for the year, while their impact was limited given their small representation in the index (see Exhibit 2). 

Global Sukuk Turned Around in Q4 2023

The global sukuk market also had a solid quarter with a gain of 4.5%, as measured by the Dow Jones Sukuk Index (ex-Reinvestment). The benchmark ended the year with a 5.5% return, falling slightly short of the 5.7% annual return of the iBoxx USD Overall, a global USD-denominated investment grade bond benchmark. The regional MENA and GCC Bond & Sukuk benchmarks gained 5.2%.

This article was first published in IFN Volume 21 Issue 3 dated Jan. 17, 2024.

How are advisors putting SPIVA data and factors to work as they build long-term plans to help clients achieve objectives? Delta Wealth Advisors’ Dino Efthimiou and Niko Finnigan join S&P DJI’s Brent Kopp for a practical look at the importance of tax management and the role of indexing in building a comprehensive plan for clients.

There are potential diversification benefits for Asian investors who incorporate U.S. equities to alleviate their tendency for a home country bias. Representing nearly 60% of the global equity market, as measured by the S&P Global BMI, U.S. equities provide a larger opportunity set outside of Asia, along with potential diversification due to different economic structures and cycles between markets, coupled with differing sector exposures. The S&P 500^®, widely regarded as the best single benchmark of large-cap U.S. equities, has an estimated USD 5.7 trillion in assets tracking¹ the index and a robust trading ecosystem. Market participants can consider using S&P 500 index-linked products to efficiently trade U.S. equities.

2023 demonstrates the impact of U.S. equity exposure for Asian investors. A slower-than-expected economic recovery in China with a continued property market downturn and ongoing U.S.-China tensions weighed on market sentiment and performance, making China and Hong Kong among the relative underperformers with their S&P BMI market indices losing 10% and 15%, respectively (see Exhibit 1). However, equity markets remained resilient in other parts of the world that had stronger economic backdrops. Easing inflation and the potential for lower interest rates led to a sharp market rally in the fourth quarter, with the S&P Global BMI closing the year with a solid 22% total return in USD. The U.S. was a standout performer, with the S&P 500 posting a 26% total return in 2023, more than offsetting its loss of 18% in 2022.

Reversals were also seen at a sector level. Information Technology was the best-performing sector, with an impressive 58% gain in 2023 following a 28% loss in 2022; the sector contributed over 50% of the S&P 500’s return in 2023. Communication Services and Consumer Discretionary also posted strong gains of 56% and 42%, respectively, after steep losses of 40% and 37% in 2022, respectively. Utilities and Energy were the only sectors that closed the year in the red after positive returns in 2022 (see Exhibit 2).

At a stock level, the contribution to the market return from a few select stocks was unusually high in 2023. The so-called “Magnificent Seven,” namely Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla, surged 112% on average over the year, contributing 58% of the S&P 500’s return. Nvidia was the best performer among them, with a 239% gain, and became the 4^th-largest stock in the index (up from the 10^th position in the beginning of the year). This rally in mega caps resulted in the largest underperformance of the S&P 500 Equal Weight Index² versus the S&P 500 (-12%) since the equal-weight index’s inception in 2003 (see Exhibit 3). With the Magnificent Seven rising 4% on average versus the S&P 500’s 1% (as of Jan. 19, 2024), the relative performance of mega caps continues to be observed as we enter 2024.

¹ Data as of Dec. 31, 2022, based on S&P Dow Jones Indices’ Annual Survey of Indexed Assets.

² The S&P 500 Equal Weight Index (EWI) is the equal-weight version of the S&P 500. The index includes the same constituents as the capitalization-weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight—or 0.2% of the index total at each quarterly rebalance. See here more information about this index.

How does screening the S&P 600 for the top 100 companies based on free cash flow yield influence performance? S&P DJI’s Michael Mell takes a custom look at the Pacer US Small Cap Cash Cows Index with Sean O’Hara, President of Pacer ETFs and Cameron Dawson, Chief Investment Officer at NewEdge Wealth.

Many investors use the start of the year to make predictions for the upcoming year and to think about ways to express views on these themes. This undertaking is not guaranteed to add value: predicting the future is incredibly difficult and success requires correctly predicting both the drivers of future performance and the upcoming impact of different market segments. The countless possible scenarios mean that is it easy to be wrong-footed.

Nonetheless, the inherent challenge of forecasting means that investors may wish to focus their attention on market segments where there is greater reward for correct insight. Dispersion provides an initial assessment of the potential reward for such insight. The greater the dispersion, the greater the potential rewards for correctly picking the best-performing constituents in that market.

Exhibit 1 shows average monthly dispersion figures for various segments over the 15-year period ending December 2023. The dispersion figures are calculated for different levels of granularity, including stocks, sectors, countries, U.S. styles and U.S. size segments. S&P SmallCap 600^® stock dispersion was the highest, on average, more than three times higher than the average dispersion among S&P 500^® sectors. Lower levels of dispersion were observed between U.S. size or style segments, or between countries or sectors in the S&P Developed Ex.-U.S. BMI.

So does this mean that investors would be well served to focus their attention on research into small-cap U.S. equities instead of other areas? Not necessarily: the relative value of insight also depends on the potential size of the positions that investors may be able to take in different segments.

An investor’s ability to take active positions is related to the average market capitalization of constituents. For example, there is more capacity to take an active position in a trillion-dollar constituent compared to a smaller constituent. Exhibit 2 plots the average dispersion figures from Exhibit 1 against the index-weighted average constituent size of the different segments over the same 15-year period (note the log scale on the y axis).

Clearly, there has been a trade-off between dispersion and the average constituent size. Higher dispersion segments, which offer greater expected reward for correct insight, may require smaller positions compared to lower dispersion segments with larger constituents.

Capacity-Adjusted Dispersion provides a way to account for capacity when considering the potential value of insight. It is calculated by multiplying the potential reward to correct selections (dispersion) and potential size of active positions (average constituent size). Exhibit 3 shows the average ratio of capacity-adjusted dispersion measures for different segments compared to that of S&P 500 stocks, based on monthly data over the 15-year period ending December 2023.

Assuming that an investor’s predictions are similarly valuable across each segment, Exhibit 3 suggests that selecting among the S&P Composite 1500^® size segments—the S&P 500, S&P MidCap 400^®, and S&P SmallCap 600—may offer more than nine times the potential opportunity compared to picking S&P 500 stocks. Similarly, choosing between the S&P 500 Growth and S&P 500 Value or selecting among S&P 500 sectors could have provided similar opportunities as picking country components of the S&P Emerging BMI or S&P Developed Ex-U.S. BMI.

Such is the difference in average constituent size that insights into S&P SmallCap 600 stocks would have to be 50 times more valuable than insights into S&P 500 stocks to provide the same capacity-adjusted opportunity.

As a result, expressing views through a U.S. size, style and sector lens could present similar opportunities as using a country lens. The relative capacity of these segments means they may offer greater opportunities than many other segments.