Drastic makeover looms for S&P 500 | Hacker News Reader

Drastic makeover looms for S&P 500

bloomberg.com

61 pointszoomablemind63 comments

I'm convinced that the markets, which, let's remember, were high on the hog all throughout the obvious impending catastrophe of this virus sweeping in from the east at the beginning of this year, until the moment reality was shoved in their faces in the form of an outbreak in Italy, have not yet absorbed the enormity of the long tail of this pandemic and the lockdown.

Is it a worse place to put your money than USD or housing? Where do you suggest we put our investments?

Fair point. It is difficult to fairly price a thing in terms of a debauched currency.

Not giving official financial advice here because I would need to understand your individual circumstances, but if you have the view that equities on the whole are going to fall, you can buy bonds, uncorrelated assets (think gold, but calculate the correlation yourself), low beta stocks, delta-neutral option strategies

There’s really a lot you can do

Bonds when interest rates are near zero?

Corporate bonds, not treasurys

VLGSX(Vanguard Long-Term Treasury Index) has actually had really good ytd returns. Dunno how long it will last.

If you expect equities to fall, zero sounds real good.

The problem is timing markets is extremely tenuous business. You may correctly time the downturn, but you may miss an opportunity when the economic picture improves. Missing just 10 good days over a span of 14 years can have an enormous impact on your returns [1].

[1] https://www.wsj.com/articles/a-crash-will-come-and-thats-ok-...

Missing just 10 bad days can improve your fortunes too. But hey, if you keep putting money on the blackjack table you're bound to make some money eventually. As long as you don't need that money for anything, the stock market is harmless entertainment. But as a small-time investor, I remember that the house always wins.

> remember that the house always wins.

In a casino, it's the impetus of the establishment to make money. In the stock market, it's the impetus of the shareholders to make money. If the house always wins[1], shareholders are the house.

1. This is a tenuous metaphor for the stock market--true in the US over long periods of time, but perpetual growth is not guaranteed.

In the case of equities timing, imo the house is not the shareholders, it's the investment bankers, hedge funds, and other major traders.

Right. My ability to trade as a small investor is after all of the quants and algorithms take their cut trading the noise of the market. Meanwhile I have an account I can look at a few times a day at most. And then I have most of my assets 401(k) that can trade once a day, at most, at a time chosen by the company the next day in funds chosen by the company.

I'm new to it myself, but I have noticed that BTC has recovered completely.

Cash? Deflation is coming?

bitcoin, just make sure you sell it after the next big rally that all the money printing sparks

What percent of public stocks are owned by funds in 401K accounts? Remember, price is driven by supply and demand. So long as there are more buyers than sellers the prices are going to keep rising. People blindly put money in funds every month. fund managers have to spread it around. Or in the case of index funds spread it by fixed formula. Sure there are good/bad companies and good/bad times, but so long as people keep pushing money in things will generally go up.

If CoViD had put white-collar people out of work, there wouldn't be any buyers and things would tank.

This is overly simplistic and, pretty damningly given the topic, fails to account for the market drop between Feb 20 and Mar 20.

When the traditional investors (as opposed to the automatic ones) sold in volume?

I think this is a great point. Retirement dollars come in a steady stream and but a consistent bid in the market. If that money flow stops, what are the implications for that buying impact. You could dig further and look at unemployments rise and see whether those who have lost their jobs typically save for retirement.

It did put white collar people out of work.

That is....one long sentence

Very tangentially, my favourite long sentence book is The Autumn of the Patriarch by Gabriel García Márquez. It was very hard to put down, not because it would've been especially gripping, but because I'd like to pause at end of a chapter, or at the very least at end of a sentence, and those sentences just went on and on for page after page.

Or they might have and are now so distorted by Fed money. You can't underestimate the power of govt money, especially in an election year.

> ... have not yet absorbed the enormity of the long tail of this pandemic and the lockdown.

I keep seeing retrospective rationalizations on Reddit saying the market "is priced in" based on a perceived mismatch between market gains and reality. I don't understand how this is true when each corner yields something unexpected.

There is a part of me that thinks we will see permanent changes from COVID-19... but then there is the part of me that remembers how quickly society can forget lessons, and how new generations can rise up and carry the world forward in unforeseen ways. I am hopeful that we will not forget this experience, but I know how far away 2008 and 2001 are in people's minds already, and I think in ten years this will be as talked about as the Spanish Flu was before COVID.

Can anyone show me an example where 'this time will be different' ever proved to be true?

Don't get me wrong, there were some changes coming that will happen and be blamed on the virus, like the death of some major retailers, a commercial real estate crash, the death of nightclubs and bars, etc. But those are evolutionary changes which have taken decades to materialize.

The things that will be permanently changed will be things that were always destined to changed but were being held back by the status quo.

Work from home for instance, many companies never wanted to even try it, even if it could save money, but now they’ve been forced to try it and actually like it, thus it will become a new status quo as people come out of quarantine and realize what a drag it is to actually have to leave their new habits and go back to shitty routines.

Same with meetings, we don’t need god damn face to face meeting for everything. A teleconference is good enough. Why bother flying across the country? Fuck it.

When was it true that "this time it's different?"

The dot-com implosion meant that you can't go public without revenue. The bar for IPOs then shifted far upward (even irrationally so) and has remained there since.

9/11 permanently moved the bar on state surveillance, war powers granted the president, and screenings. That mostly hadn't happened after prior hijackings or accidents.

The Columbia disaster killed the Space Shuttle Program.

There are many events that permanently transform affected systems. Coronavirus is a once in a century curveball and we are in the first chapter of many in the COVID-19 book. Many things will change. We don't know how many yet.

There will be some retailers and airlines who do go bankrupt, and we might see a shift to more teleworking for white-collar workers but apart from that even if there is a second wave this fall it will still be remembered 5 years from now as a non life-changing event.

Spanish flu probably had a death rate >=10x covid, and even with that society did not change to much. https://www.weforum.org/agenda/2020/04/covid-19-how-spanish-...

This will not stop politicians from both parties from trying to use the crisis for political gain.

> “It was more happenstance than actual foresight that those companies would end up getting worse,” said Keith Gangl, portfolio manager for Gradient Investments

Sounds like sour grapes to me. I imagine this is the line this guy is feeding all his investors when they ask why they're paying him 1% and getting beat by the S&P.

Since passive funds mostly weigh investment by market cap or some other indicator of size that’s already gotten smaller for these firms I’m not sure swapping out the smallest 30 would make up more than a few percent of allocated funds.. far from drastic for the passive investor. From the firm perspective it’s also hard to quantify the effect on stock prices from dropped firms when the reason they’re being dropped is their market cap shrunk— there’s a chicken vs egg quality to the situation. Obviously some institutions will be forced to sell but the market is generally efficient in the long run— it’s not like getting dropped affects the underlying business value. In the short term the businesses will have less access to newly issued equity capital however.

Won't alter the price very much, as the institutional boys following this would have assumed it would happen.

The market is very decidedly not the economy. Everything indicates disaster for the gdp, which is a measure of economy. But the market is sitting about where it was 1 year ago. People expect that America is going to pull through. Sentiment may change but right now its pretty bullish. Lots of retail investors driven by FoMo, of course, and people who rushed in to buy the dip. Google trends is illustrative of the point.

But I think the corporate debt, unemployment, a possible trade war, supply shortages, and eventual bankruptcies are going to send it back down at some point.

So there's a problem with thrashing... Where deeply down companies may drop out of the index on this rebalance but come back in sometime down the road, in a quarter or 2. The CRSP indices, for example, solve this problem by buffering between the market cap segments. The S&P should introduce a similar mechanism to it's methodology. This would also reduce index rebalance trade aheads and thus reduce costs.

> the index committee is probably hesitant to add more technology firms

This surprised me. I had thought that S&P 500 was an objective list of large cap stocks, without subjective decisions about which companies to include.

Nope. Lots of opinion involved, especially in the "representative of the US economy" bit. https://en.wikipedia.org/wiki/S%26P_500_Index#Selection_crit...

Calling it now, this is going to result in a huge scandal. Due to the sheer size of investments based on the index, influencing those opinions will become very valuable for certain players.

There could be a scandal, but how would it be "huge"?

You could throw darts at a list of large companies and weight them with some really dumb rules and get an index that's pretty close to "the market"; that's basically what the Dow is.

The difference between even the S&P 500 and a total market index (i.e. all the smaller stocks that exist) is pretty insignificant to returns (and recently bad for them), and I believe the total market funds have become more popular than the traditional S&P 500 ones anyway.

The timing of when individual stocks are added or removed from the index seems like valuable information to holders of those stocks.

It's one form of possible insider trading among many.

In any case, one of my points is, say you want a fund that tracks the stock market, a Vanguard index fund maybe, and you are concerned about their S&P 500 fund being gamed or "front-run" or whatever you want to call it. You don't trust it. They have a "total market" fund with the same 0.03% expenses. Plus, the AUM are the same or a little more, so you don't even have to go against the herd. So if something did happen to the S&P 500 fund, it seems like it would be inconsequential. Who needs it? And people are going to notice if something is wrong because the differences between the S&P 500 fund and the S&P 500 index, or between the fund and the total market, are so small.

What you need to worry about is some obscure index fund where everybody is not aware of what it should return. Like, I don't know, USO?

As a holder of S&P 500, it won't look big. As a majority stakeholder in a company that is on the border, it will.

I'm not so sure the index committee can do much. So yes, there's a board of human beings that oversees the mechanical rules that form the S&P 5... But they mainly stand in as tie breakers. Tie breaking usually happens at the bottom of the market cap range where were mainly looking at promotions from the midcaps..

https://outline.com/HjUNun

My own personal view as someone who works in Wall Street (but not in trading) is that the market is currently too optimistic in the wake of surprisingly positive (or "not terrible") Q1 2020 earnings reported in early April. The problem is that those earnings don't really say anything about the world we live in today, because (a) the U.S. only really started panicking in mid-March, when most of Q1 was already over and (b) companies did their very best to make Q1 look as good as possible since they realized Q2 was going to be absolute shit anyway. That includes trading long-term, sustainable results (good) for near-term gains (bad, but which they felt "necessary" given the current environment) including not only cost-cutting and "rightsizing" but likely some liberal / aggressive accounting.

At work, people say we're in the second inning of the COVID-19 game, and although I hate baseball, I tend to agree. Valuation multiples have essentially recovered to pre-COVID-19 levels. The S&P 500 was down only 10% this year (as of some date last week). Intuitively, does anyone feel the economy is just "10% worse"? Especially coming off of record highs that many already felt were in need of a correction...

I think the "second wave" everyone keeps worried about is more likely to be defined not only by a surge in cases but perhaps more significantly by the massive market crash as the current house of cards begins to unwind. Grab your hot dogs, the third inning is about to start.

I don't think market is optimistic (ex. projections from pretty much every investment bankers), but instead reality is extraordinarily distorted by massive cash infusion and govt's commitment to not let market go down at any cost. This makes asset pricing as dictated by US government as opposed to market forces (same as in countries like Russia). This is first time in history where stock price is rising literally in proportion to job loss and revenues loss!

The jury is still out on whether those measures will be effective, though. To date, they really haven't done much. Unemployment is at 15% and expected to hit 20% in the next month or so, to name just the most obvious data point.

I dunno, 10% worse sounds about right to me. NYC was the absolute worst case, and the city's having a very tragic time but ultimately still providing all goods and most services expected in modern life. Most places were hit nowhere nearly as badly, and current data suggests it'll stay that way. I think it's hard to argue the economy is 30% worse or 50% worse without invoking very pessimistic assumptions about what the next few months are going to look like.

Anywhere between 13% to 19% of Manhattan has left NYC. In the affluent neighborhoods, the rate is more like 40%.¹

We came into this crisis off of the longest prosperity period in modern history. I suspect the more profound impact is still to hit.²

__________

1. https://www.nytimes.com/interactive/2020/05/15/upshot/who-le...

2. Just one example from this week https://www.wsj.com/articles/coronavirus-to-slow-u-s-meat-pr...

These sound like examples of how the worst is indeed behind us. It seems unlikely that another 40% of people will leave affluent Manhattan neighborhoods over the next few months, or that meat production will be slowed more than it has been over the past month.

The issue is the impact of those disruptions hasn't really hit the real economy just yet. That lag is what I'm suggesting is being ignored.

I mean, just look at this chart https://i.stack.imgur.com/cGIoq.png and tell me if those trends seem normal to you at all.

I think it's being properly accounted for. On March 23, nobody had any real idea how severe lockdowns would be or how long they'd last; reasonable estimates had 20-30% unemployment rates, and there were serious arguments from knowledgeable people that we should keep lockdowns in place for 2/3 of the next 18 months. It makes sense for the markets to rally as we discover that unemployment isn't quite that bad and lockdowns won't last nearly that long.

More generally, it's not surprising that a forwards-looking metric and a backwards-looking metric don't move together over the course of a month.

Unemployment isn't quite that bad? The 20% is looking quite possible.

> The picture looks worse through the lens of new claims for unemployment benefits—a proxy for layoffs. Workers filed 26.5 million claims for unemployment benefits from March 15 through April 18—the weeks covered by the April jobs report. This is equivalent to 16% of the U.S. labor force seeking aid, which would suggest an unemployment rate above 20%. (Another 3.8 million filed the following week, which will be reflected in the May report.)

https://www.wsj.com/articles/april-jobs-report-likely-to-sho...

Wall Street has no idea which direction the economy is going to go, and stocks keep rising despite the fact that uncertainty mandates prices go down. Disparity in equity research earnings estimates has reached near record levels (actual peak was 19% in April 2009):

https://i.stack.imgur.com/bjlj2.png

I think it’d be more concerning if this wasn’t the case...

I guess while the average passive investor doesn't care (in that this reshuffling will happen under them mostly without their knowledge), it seems like a great front-running opportunity for the banks and active managers. A lot of money gets put into the S&P 500 and it must create quite a bit of buy-side demand.

Just so we are clear, front-running means something very specific in trading and active managers preparing for index changed isn’t it.

In fact this sort of change has long been priced into the market, it won’t change prices much at all when it happens.

Ah, the great "it's priced in" - but is it really? I guess nobody can really know, unless you're one of those that says the market is always correct.

And yes, there's front running an individual trade, but I was thinking a much longer timeframe, although I don't know what the right word for it would be. Would that be considered momentum? Pre-momentum?

Well, you can know, by looking at whether or not there's a change in stock price upon announcement of inclusion in an index, right?

https://www.nber.org/digest/nov13/w19290.html

It appears that it's not entirely priced in.

No idea what the right word for what you are saying is. But it’s not front-running. Using front-running here would be similar to if I described a social engineering hack as a “zero-day”. Except worse as front running is frequently legally defined by groups like the sec & finra.

The index rebalance trade is as old as time... Nothing new. Arbitrageurs take risk to provide liquidity on the rebalance day. You need to get paid for that risk. So they do the market a service.

https://archive.md/yWOah

I wonder how buying high and selling low (the strategy of S&P 500 holders) will work out in this new COVID era.

What makes you think that SP500 index funds, which are cap-weighted, amount to buying high and selling low?

Companies leave the index when they fall below a certain market cap. Companies enter the index when they are above a certain market cap. That is literally the definition of buying high and selling low.

The turnover rate is low and the weight of those companies in the index is very small. That said, I prefer broader indices.

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