US bank share prices have come roaring back since the global financial crisis and the financial industry is now challenging technology as the largest sector in the S&P 500.
Technology accounts for 17.7 per cent of the index, broadly unchanged since March 2009 and just ahead of the financial sector on 16.8 per cent.
That’s almost double 2009’s low of 8.6 per cent, when the sector sank to sixth in terms of its weighting.
Sector weightings can indicate when both bubbles and crashes are in motion. Technology, which accounted for just 6 per cent of the index in 1990, topped out at 29 per cent in 1999 before more than halving by 2002.
Similarly, financials accounted for 22 per cent of the index in 2006, almost triple its 1990 weighting.
Rising earnings and dividend growth are driving the banks’ resurgence – were it not for banks, overall S&P earnings would actually be lower this quarter.
Cohen has the edge in hedges
Hedge funds gained an average of 1.4 per cent last month – their best performance since January, albeit nowhere near the S&P 500's 5 per cent gain.
It’s a familiar story. Hedge funds are up 4.7 per cent in 2013, compared to the S&P 500’s 16 per cent. Since January 2010, hedge funds have generated gains of 14.5 per cent after fees, compared to the S&P 500’s 55 per cent gain (a figure 85 per cent of hedge funds failed to match).
Over five years, hedge funds have averaged gains of 1.7 per cent, compared to 7 per cent for the S&P 500. The figures are equally stark over 10 years.
Despite huge fees and lack- lustre performance, hedge fund assets have ballooned from $626 billion in 2002 to $1.7 trillion in 2007 and $2.25 trillion today.
One exception has been the enormously successful Steve Cohen (above), who is facing insider trading charges.
Cohen reportedly hates the word "edge", often seen as a euphemism for insider knowledge. However, the only thing worse than having an edge, as Oscar Wilde might have said, is having none at all.
Investors have little to fear, says the Vix index
US investors seemingly haven't a care in the world. With indices near all-time highs, the Vix, or fear index, last week fell to 11.8 – its lowest level since March and more than 40 per cent lower than June's high.
Complacency? Bears argue that reversals often follow when volatility collapses. Such readings, they note, were last seen on February 26th, 2007, just before the Vix soared by 64 per cent – its largest ever one-day spike. The Vix’s current level is in the bottom 10 per cent of readings, well below its historical average (20) and nearing 1993’s all-time low (9.3).
However, volatility can remain low for extended periods, as it did between 2004 and 2007. Bulls argue this is a similarly low-volatility environment.
Europe's VStoxx, like the Vix, is currently subdued. However, volatility expert Bill Luby recently noted that deviations among risk measures have widened dramatically over the last year.
On July 15th, for example, the Nasdaq-100 Volatility Index recorded one of its low- est readings of the last year.
On the same day, Luby noted, China's volatility index hit one of its highest of the year. In a globalised world, investors looking for an "early warning system" need to look well beyond the US, Luby advises.
September not looking for calm to continue
Blackrock strategist Russ Koesterich is a bull, but he doesn't expect the volatility lull to continue. Why?
Important federal elections are held in Germany next month, so Europe is “likely to re-emerge as a source of volatility”.
Tapering anxiety ahead of the Federal Reserve’s September meeting is also likely, while the US budget debate “will heat up again” before September 30th, the deadline for a budget resolution from Congress.
Finally, September is one month “when the calendar really does matter”, having a consistent negative bias for over the last century in the US.
It has also been the worst month in Japan and many European markets, including the UK and Germany.
Red faces as fund staff take passive approach
The active investment industry was recently embarrassed by a poll that found some two- thirds of active fund staff invested passively.
The poll, by Financial Times publication Ignites, prompted predictable excuses from active advocates.
However, the active-passive debate was won long ago, as index investing guru Larry Swedroe noted last week.
Last year, said Swedroe, 37 per cent of managed fund beat their benchmarks. Over five years, just 25 per cent outperformed.
Over 10 years, only 17 per cent outperformed, with an incredible 51 per cent of funds closing.
As for that FT poll, it’s not surprising that active staff prefer cheap index funds; the only thing that’s surprising is they admitted it.