This article discusses how right now, “low quality” equities are outperforming “high quality” equities, and relates that to “risk-on” and “risk-off” cycles. The implication here is that we are in a “risk on” market, since cyclicals and these “low quality” equities are outperforming.
What I find interesting in the article is the definition of low quality and high quality.
“One factor S&P Dow Jones indices uses in their stock classifications is an Earnings and Dividend Quality Ranking measurement. The basis for this measurement is to provide investors with a ranking that S&P evaluates based on a company’s stability of earnings and dividend over time. The highest ranking is A and the lowest is D (a company in reorganization).
With this as a background, S&P has constructed indices based on these rankings. The S&P 500 High Quality Rankings Index consists of stocks with a ranking of A and better. The S&P 500 Low Quality Rankings Index consists of stocks with a ranking of B or lower.”
Then this chart:
So, if the scale is A to D, and A is high and B-D is low, then why wouldn’t the returns average to the overall return? Or at least include it?
Well, it turns out that the indexes do not necessarily comprise the entire S&P. In fact, right now they only include 300 of the S&P500 stocks between them.
Not only that, but the Quality indexes are not cap weighted. They are weighted based on the ranking. This will invariably result in a small cap bias, and in fact might be compared to Rob Arnott’s monkey weighting.
Index methodology is so fun!