Why is E&R seeing no recession?
Should an Index be designed with an intrinsic capability to anticipate and be a true bellwether? This question can evoke a lot of debate because the whole thesis of modern finance is built around the inability of forecasters to forecast.
So, if forecasters can’t forecast, we are left with S&P 500, a concentrated benchmark, where 50 stocks out of 500 own near 51% of the S&P 500 value and which assumes to do a good job to represent the market. If the Index goes down, mass perception could consider that as a sign of recession. If it goes up, one could believe that the recession is over and we are are out of the woods.
Following the incumbent benchmark means heavily relying on the top 50 companies and tracking them. This inverts the whole logic of systematic risk on its head. Is the market the horse leading the cart or is it the cart of 50 components leading the horse? You may not have thought of this distorted logic, but then it’s up to you to question it and wonder, if the S&P 500 can’t fix the concentration in your pension portfolio, how can it ever be a good representative benchmark or give insights around recession.
This means going up does not mean anticipation of no-recession and going down does not mean confirmation of recession. However, assuming Exceptional & Rich [E&R] 500 fixes the concentration problem and does the impossible that’s beating the S&P 500, it should naturally be a better benchmark, whose going up and down would carry some predictive weight. And if E&R has some predictive weight, the following sector break up from January 2023 would mean something.
The U.S. Consumer Discretionary sector at 20.82% is its top-weighted sector. According to the Exceptional & Rich method, the only way a sector can have higher probability of increased allocation is if it is either persisting and is top ranked among other sector peers or the respective sector is underperforming and is bottom ranked among sector peers. The latter seems to be the case. The sector is down below the 20% level for 2022, as measured by popular sector ETFs.
The E&R method seems to indicate that wherever the world is going, in a slowdown, recession, or depression, back to exuberance, or nowhere, the Consumer Discretionary sector should benefit and potentially outperform other sector peers over time.
It would be fascinating to see how a Consumer Discretionary sector could potentially outperform, if we are entering a recession. The performance attribution of Consumer Discretionary would be an interesting statistic to measure over the next 12 to 36 months.
Description
Exceptional & Rich U.S. 500 Index [E&R 500] has been created to improve the statistical and scientific design flaws of the S&P 500.
Unlike the S&P 500 which is risk-increasing and return-reducing owing to its concentration, the E&R is designed to own 500 large-cap U.S. equities, and deliver higher risk-weighted excess returns while maintaining low tracking error vs. the S&P 500.
Index Attributes
Launched on January 3, 2023, the E&R 500 leads a new generation of Smart Beta Indices that electronically deliver investable fund processes direct to Institutional and Individual investors. The lack of secondary market delivery is an essential attribute for the service as it reduces the overall systematic risk inherent in Exchange Traded Funds today and allows the final investor to only pay for alpha above the S&P 500.
Methodology
E&R methodology is based on a mathematical and physics innovation, which combines the mathematical process of Preferential Detachment with Preferential attachment and explains their interaction using the [3N] model, a conceptual mechanism explaining the functioning of Nature. The method allows a dynamic scoring of any set of components in a group, weighting and rebalancing them dynamically to deliver higher risk-weighted excess returns. The method removes the conflict between Efficient and Inefficient market thinking, statistically normal and non-normal behavior, or in simple terms the conflict between Value and Growth investing. The methodology is dynamic, not Size biased, and obviates the need for concentration and running after winners but rather adopts a slower weight readjustment compared to the S&P 500.
Check out the AlphaBlock Sandbox for the Exceptional & Rich Indexes methodology and simulations.
Bibliography
[1] M. Pal, Mean Reversion Framework, SSRN, May 2015
[2] M. Pal, Markov and the Mean Reversion Framework, SSRN, May 2015
[3] M. Pal, How Physics Solved your wealth problem, SSRN, October 2016
[4] M. Pal, The Beta Maths, SSRN, March 2017
[5] M. Pal, [3N] model of life, SSRN, April 2021
[6] M. Pal, The Snowball Effect, SSRN, July 2022
[7] M. Pal, Momentum and Reversion, August 2015
[8] M. Pal, M. Ferent, Stock Market Stationarity, SSRN, September 2015
[9] M. Pal, Reversion Diversion Hypothesis, SSRN, November 2015
[10] M. Pal, M. Shah, A. Mitroi, Temporal Changes in Shiller’s Exuberance Data, SSRN, February 2011 [11] M. Pal, The S&P 500 Myth, SSRN, July 2022
[12] M. Pal, The Size Proxy, August 2017
[13] M. Pal, Human AI, SSRN, July 2017
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