Investment Insights

Downside analysis of the S&P 500 Index

By Mark Shore/Coquest Advisors

Since the financial crisis, the U.S equity markets appreciated from their 2009 lows, making new highs with a few corrections along the way. However, as the markets experienced increased volatility recently, and economists talk of a late economic cycle, this seemed to be an appropriate opportunity to examine the downside of the equity markets.

This study focuses on the S&P 500 index (SPX) negative quarters since 1980 and the behavior of managed futures (CTAs) and real estate (REITs). Did they offer any downside protection during those negative quarters?

In recent years, managed futures returns, in the aggregate, have been challenging. The BarclayHedge CTA index contains several hundred funds representing various managed futures styles. However, trend-following systematic funds are the majority of the managed futures industry. 

Background Statistics:

There are 158 calendar quarters from January 1980 to June 2019. The SPX was negative 50 quarters or roughly 32% of the time. What does equity behavior look like in that 1/3 time frame?

Figure 1: The five largest negative SPX quarters from January 1980 to June 2019

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Source: Bloomberg data. Indexes include S&P 500 Index, FTSE REIT Index, BarclayHedge CTA Index.


Figure 1 demonstrates three items: 1) during the top 5 largest equity quarter declines, REITs were also negative, while managed futures experienced positive returns. 2) REITs outperformed SPX in three of the five quarters. Managed Futures outperformed SPX by a wide margin in each quarter. 3) The five largest SPX quarterly drawdowns occurred in the 3rd and 4th quarters of their respective years, which begs the question, are SPX quarterly drawdowns induced by seasonality? I’ll address this question in a future article.

The correlation matrix in Figure 2 points out CTAs are non-correlated to both benchmarks. See February article for rolling correlations. What about negative quarter correlations? Figure 3 illustrates managed futures becomes more negatively correlated to both indices during environments of stress, supporting the results in Figure 1.

Results:

Figure 2: Correlations for all 158 quarters

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Source: Bloomberg data. Indexes include S&P 500 Index, FTSE REIT Index, BarclayHedge CTA Index.


Figure 3: Correlations when SPX quarters were negative

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Source: Bloomberg data. Indexes include S&P 500 Index, FTSE REIT Index, BarclayHedge CTA Index.

Figure 4: Negative SPX quarters Jan 1980 to June 2019.

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Source: Bloomberg data. Indexes include S&P 500 Index, FTSE REIT Index, BarclayHedge CTA Index.

Several items to note in figure 4:

1) Managed futures has a positive average return during the 50 SPX negative quarters.

2) The maximum difference between SPX and REITs was 17.04% in Q2, 2002 when SPX declined 13.7%, and REITS appreciated 3.3%. The same quarter managed futures increased by 8.2%.

3) The maximum difference between SPX and CTAs was 42.3% in Q1, 1980 when SPX = -5.4% and CTAs increased by 36.9%. REITs = -6.62% in that quarter.

4) Managed futures outperformed SPX 82% of the time and outperformed REITs 72% of the quarters.

5) REITs are negative 66% of the quarters. The average negative REIT quarter = -8.26% has more potential tail risk than SPX. The Managed futures index is negative 21% of the time with an average negative quarter of -2.62% and the worst quarter at -8.7% that occurred in Q1, 1992. During that quarter SPX = -3.2% and REITs = -1.2%. 

Figure 5: CTA returns relative to SPX, and REIT returns relative to SPX

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Source: Bloomberg data. Indexes include S&P 500 Index, FTSE REIT Index, BarclayHedge CTA Index.

Figure 5 shows, in most cases, both REITs and managed futures outperformed equities during the negative SPX quarters. Managed futures underperformed SPX in the single digits, but did not go below -8.7% and REITs in more recent quarters on a few occasions underperformed by a wider margin.

Summary:

No one knows when the next equity market decline or economic contraction will occur. An investor knowing their choices to reduce downside risk may offer assistance in the long-run.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Coquest Advisors or TEXPERS, and are subject to revision over time. 

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