Q4 2018 Market Commentary

Highlights

  • Market performance in December worst since Great Depression
  • The downturn in Q4 was market-wide. We expect Stratified Weight to outperform as Business Risk trends emerge in recovery
  • FAANGs lose their bite
  • SEADM outperforms EAFE by 2.6% in 2018
  • Stratified LargeCap outperforms Equal Weight by 1.2% in 2018
  • Stratified MidCap outperformed the S&P MidCap 400 by 3.6% in 2018

Market performance in December is worst since Great Depression

Performance does not reflect fees or implementation costs as an investor cannot directly invest in an index.
Summary: Though the volatility in October and November seemed to be driven by earnings season, the downturn in December was driven by broad market factors. 
  • Concerns about future US growth and US interest rate rises weighed heavily - the US yield curve briefly inverted (3s and 5s) in early December, suggesting that a recession looked likely in the near future. 
  • Political pressures added to the volatility. The US midterm elections saw Democrats win the House of Representatives and left Congress divided. 
  • The US-China trade dispute continued, with escalation only paused by a temporary truce struck in December. 
  • Markets had their worst quarter since Q3 2011 and their worst December since 1931. The S&P 500 fell 13.5% over the quarter, with the Syntax LargeCap Index outperforming by 30 bps (-13.2%). 
  • Weak results from several large cap tech companies, fears of a recession, coupled with rising interest rates and political turmoil saw markets sell off and volatility rise. The VIX doubled from 18 on December 1 to 36 by Christmas Day.

The downturn in Q4 was market-wide

Summary: The downturn in Q4 was market-wide. We expect Stratified Weight to outperform as Business Risk trends emerge in recovery.
  • The decline was market-wide, with all eight Syntax sectors falling and seven out of eight sectors falling by a similarly extreme amount 13-15%. Sectors were negative in both the 500 and 400 indices.
  • This is indicative of a market-wide sell off and is often followed by a market-wide recovery, where Stratified Indices outperform their cap-weighted counterparts (e.g. March 2003 or March 2009).

Performance does not reflect fees or implementation costs as an investor cannot directly invest in an index. The inception date of the Stratified LargeCap Index is December 27, 2016. Data for this index prior to that date is backtested. Please see important disclaimers regarding backtested data prior to inception.

FAANGs lose their bite

Summary: Widely reported in the financial press, overconcentration in the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google/Alphabet) dragged the benchmark lower with a string of disappointing announcements. 
  • This theme continued into 2019 as Apple lowered Q1 guidance - its trillion dollar market value looks like a distant memory after Apple ended the quarter down 29.9%.
  • In the cap-weighted benchmark these securities’ outsize weights, which previously lifted the S&P 500 higher, meant their downturn had a disproportionate impact. The FAANG companies had 12.8% weight in the benchmark at the start of the quarter, so that their poor performance alone accounted for the S&P 500 dropping 2.9%. In contrast, they were only 0.8% weight in the stratified 500, contributing just -0.2%.

SEADM outperforms EAFE by 2.6% in 2018

Performance does not reflect fees or implementation costs as an investor cannot directly invest in an index.
Summary: While volatility in the US was market-wide in 2018, international market saw broad sector themes emerge. As a result the spread between sector performance was wider and Stratified Weight outperformed. 
  • Stratification reduced the business risk concentrations in Financials, Industrials, Consumer (autos) and hence SEADM outperformed by 2.6% (SEADM fell 10.6% versus 13.2% for MSCI EAFE).
  • International headwinds look set to continue in 2019. Tensions build around Brexit on March 29th, and European Elections in May. Meanwhile protectionist trade measures continue to gain traction. 
  • Therefore, we believe that the business risk diversification offered by SEADM is the best approach to gain international exposure while avoiding potentially painful overexposure to particular sectors.

Stratified LargeCap outperforms Equal Weight by 1.2% in 2018

Summary: Stratified LargeCap outperforms Equal Weight by 1.2% in 2018 and the underperformance of Equal Weight in 2018 was largely due to poor diversification of business risk.
  • While an equal weight methodology is seen by some as delivering adequate diversification, it still leaves the index exposed to specific sectors and Related Business Risks. 
  • In an equal weight index those sectors with the most stocks are given the most weight. 
  • These sectors are Industrials (16.8%), Financials (15.6%) and Information (16.0%). All three sectors were among the worst performing sectors in Q4. 
  • Furthermore, the S&P 500 Equal Weight Index missed out on less populous sectors such as Food and Information Tools, which were among the best performing.
  • The RAFI US 1000 Index and DFA Core Equity 1 Portfolio had even lower performance than the S&P 500 Equal Weight Index, returning -8.3% and -8.7% in 2018.
 

Stratified MidCap outperformed the S&P MidCap 400 by 3.6% in 2018

Performance does not reflect fees or implementation costs as an investor cannot directly invest in an index.
Summary: Stratified MidCap fell 7.5% in 2018 versus the S&P MidCap 400 which fell 11.1%, outperforming by 3.6%. Similar to equal weight above, stratifying the mid cap universe is a business risk diversification story. 
  • In the large cap universe, stratification removes idiosyncratic/stock-specific concentrations (e.g. FAANGs) as well as company type concentrations. Whereas in the mid cap universe, because the weights are in a tighter band, cap weight lacks the mega cap company concentration problem seen in the S&P 500. However, equal weight still has sector biases that stratification removes. 
  • The S&P MidCap 400 has large overweights in Industrials (22.8%) and Financials (21.6%), both of which significantly underperformed (-15.2 and -14.3% respectively). 
  • The Stratified MidCap Index diversified these sectors more effectively and hence outperformed its cap-weighted counterpart.

Sector Takeaways

Energy splutters in Q4
  • Concerns about growth, and easy supply conditions saw WTI fall from its year high of $76 in early October to finish the year at $45. 
  • At the end of Q3, energy stocks in the Stratified Weight and cap weight 500 had posted strong returns for the year (8.6% and 6.0% respectively). 
  • However, the fall in oil prices in Q4 saw these gains erased. Mid cap energy companies had an even tougher time in Q4: the stratified sector lost 16.8% and the cap-weighted sector dropped 23.2%.
 
Stratified Healthcare underperformed due to Merck and Pfizer
  • In Q4, the stratified large cap Healthcare sector gave up its gains for 2018 (finishing down -1.4%), as the S&P 500 Healthcare sector rose 6.5%. 
  • The outperformance of the cap-weighted Healthcare sector was largely due to strong performance of Merck and Pfizer (+40.0% and 24.8%), two of the largest healthcare companies in the S&P 500 with market caps of almost $200b and $250b.
  • Excluding Merck and Pfizer, the cap-weighted Healthcare sector returned only 3.5% in 2018. 
 
Consumer sector hurt by Amazon headwind 
  • The Stratified Weight large cap Consumer sector fell 14.6% in Q4, underperforming the cap-weighted sector by 2.9%, due to falling US growth expectations and pricing pressures from Amazon. 
  • Supply pressures caused by the ongoing trade disputes were also a headwind. 
 
Industrials fall on growth concern
  • The growth concerns and trade disputes also strongly impacted Industrials. 
  • The only companies in the sector with positive returns in Q4 2018 were Rockwell Collins, which was acquired by United Technologies, Ball Corp., and Newmont Mining (3 out of 85 companies rose). 
  • Defense performed particularly badly, due in part to the White House’s softening foreign policy positions (announcing plans to withdraw troops from Syria and Afghanistan, and the departures of Mattis and Kelly).
 
Comfort Food
  • As is usually the case when markets become stressed, defensive sectors such as Food perform well. 
  • Food was the best performing sector last quarter in both cap weight and Stratified Weight (-5.5% and -6.4%). 
  • The outperformance of the cap-weighted sector stemmed from particularly strong returns by the largest companies, namely Starbucks (+13.9%) and McDonald’s (+6.8%). 

Disclaimers

Past performance is no guarantee of future results. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The inception date of the Syntax Stratified LargeCap Index and Syntax Stratified Sector Indices was December 27, 2016. The inception date of the Syntax Stratified Europe & Asia Developed Markets Index was January 1, 2016. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index. Charts and graphs are provided for illustrative purposes only. 

The Syntax Stratified LargeCap Index, Syntax Stratified MidCap Index, and Syntax Europe & Asia Developed Markets (“SEADM”) Index are the property of Syntax, LLC, which has contracted with S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC) to calculate and maintain the Indices. The Indices are not sponsored by S&P Dow Jones Indices or its affiliates or its third party licensors (collectively, “S&P Dow Jones Indices”). S&P Dow Jones Indices will not be liable for any errors or omissions in calculating the Index. “Calculated by S&P Dow Jones Indices” and the related stylized mark(s) are service marks of S&P Dow Jones Indices and have been licensed for use by Syntax, LLC. S&P® is a registered trademark of Standard & Poor's Financial Services LLC (“SPFS"), and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). The MSCI EAFE Index was used by Syntax, LLC as the reference universe for selection of the companies included in the SEADM Index. MSCI does not in any way sponsor, support, promote or endorse the Index. MSCI was not and is not involved in any way in the creation, calculation, maintenance or review of the Index. The MSCI EAFE Index was provided on an “as is” basis. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating the MSCI EAFE Index (collectively, the “MSCI Parties”) expressly disclaim all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non‐infringement, merchantability and fitness for a particular purpose). Without limiting any of the foregoing, in no event shall any of the MSCI Parties have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages in connection with the MSCI EAFE Index or the SEADM Index. Prior to March 19, 2018, the SEADM Index was calculate by NYSE. Sector subsets of the Syntax Stratified LargeCap, Syntax Stratified MidCap, and SEADM Indices are calculated using model performance generated in FactSet, and as such may differ from index calculations performed by S&P Dow Jones Indices. Syntax®, Stratified®, Stratified Indices®, Stratified-WeightTM, and Locus® are trademarks or registered trademarks of Syntax and its affiliate Locus, LP. FactSet® is a registered trademark of FactSet Research Systems, Inc. 

Index performance does not represent actual fund or portfolio performance and such performance does not reflect the actual investment experience of any investor. An investor cannot invest directly in an index. In addition, the results actual investors might have achieved would have differed from those shown because of differences in the timing, amounts of their investments, and fees and expenses associated with an investment in a portfolio invested in accordance with an index. None of the Syntax Indices or the benchmark indices portrayed herein charge management fees or incur brokerage expenses, and no such fees or expenses were deducted from the performance shown; provided, however that the returns of any investment portfolio invested in accordance with such indices would be net of such fees and expenses. Additionally, none of such indices lend securities, and no revenues from securities lending were added to the performance shown.  

The S&P 500® Index is an unmanaged index considered representative of the US mid- and large-cap stock market. The MSCI EAFE Index is an unmanaged index considered representative of the European, Australian, and East Asian large-cap stock market. Benchmark data for the S&P 500 and S&P MidCap 400 Indices are provided by S&P Dow Jones through FactSet®. Benchmark data for the MSCI EAFE index is provided by MSCI through FactSet.

This document is for informational purposes only and is not intended to be, nor should it be construed or used as an offer to sell, or a solicitation of any offer to buy, any security. Additionally, the information herein is not intended to provide, and should not be relied upon for, legal advice or investment recommendations. You should make an independent investigation of the matters described herein, including consulting your own advisors on the matters discussed herein. In addition, certain information contained in this factsheet has been obtained from published and non-published sources prepared by other parties, which in certain cases have not been updated through the date hereof.  While such information is believed to be reliable for the purpose used in this factsheet, such information has not been independently verified by Syntax and Syntax does not assume any responsibility for the accuracy or completeness of such information. Syntax LLC, its affiliates and their independent providers are not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein.

Certain information contained in this presentation is non-public, proprietary and highly confidential and is being submitted to selected recipients only. Accordingly, by accepting and using this factsheet, you will be deemed to agree not to disclose any information contained herein except as may be required by law. This factsheet and the information herein may not be reproduced (in whole or in part), distributed or transmitted to any other person without the prior written consent of Syntax. Distribution of Syntax data and the use of Syntax indices to create financial products requires a license with Syntax and/or its licensors. Investments are not FDIC insured, may lose value and have no bank guarantee.