The Investment Scientist

Posts Tagged ‘performance

ImageSince its inception on March 9, 2003, RSP has returned 193%. At the same time, SPY has only returned 97%. This is extremely puzzling as both RSP and SPY hold the same S&P 500 stocks.The only difference is that SPY is a cap-weighted fund and RSP is an equally-weighted one. This begs the question, is RSP’s outperformance normal; and more importantly, is it likely to continue?

To answer the question I asked my intern Nahae Kim to run a regression based on the Nobel Prize winning Fama-French Three Factor Model.

R(x) – rf = alpha + beta1*(Rmkt – rf) + beta2*SML + beta3*HML

Where R(x) is the return of the selected fund, x being either RSP or SPY, alpha is the “skill” of the fund, beta1 is the market risk loading, beta2 is the small cap risk loading and beta3 is the value risk loading.

Here is what I got from the two regressions.

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Image2013 has been a stellar year for stocks. As of today, the S&P 500 is up more than 25%. There are about ten trading days left and barring unforeseen circumstance, the index will end the year in the 20+% range.

A few of my clients are concerned; with the market doing so well this year, what does that bode for 2014? Well, I don’t have a crystal ball, so all I can do is to look at historical data to make an imperfect reference.

To answer the question, I asked my intern Nahae Kim to do a study of the relationship of immediately subsequent year returns. Specifically, can one year return predict the next year?

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There have been 17 government shutdowns in history. Today I asked my intern Taro Taguchi to analyze the market performances subsequent to shutdowns.

Using the closing price prior to the day of government shutdown as a base line, he found on average, the market rose 0.97% in one month, 2.38% in three months and 13.42% in a year.

If we isolate the 5 most severe shutdowns that lasted more than 10 days, the picture is a bit worse, but not by much. On average the market fell 4.19% in one month, fell .18% in three months and rose 9.63% in a year.

These historical precedents confirm my gut feeling that a government shutdown is really no big deal, as far as the market is concerned.

More worrisome is the upcoming debt ceiling fight. There is no precedent of US default to guide my outlook on this, but the longer the government shutdown lasts, the deeper heels get dug in by both parties and the more likely a default. Nevertheless, I’m still thinking that will also be a storm in a tea cup.

The bottom line is these are issues beyond our control, there is no point worrying about them. If worst comes to worst (ie default,) and the market should drop 20%. That’s actually great because then we can buy shares at a discount!


Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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