Markets in recent weeks have largely been moving in reaction to first quarter earnings reports.
U.S. stocks yesterday slumped to the lowest in six weeks on doubts that corporate profits can withstand rising interest rates, after the highly anticipated results from Alphabet Inc., Texas Instruments Inc., and Microsoft Corp. disappointed markets.
The S&P 500 dipped 2.8% during regular trading yesterday, while its equal-weighted counterpart fell just under 2% during the same period.
“There is single security risk with market-cap weighted sector ETFs as one or two companies are dominating the portfolio,” Todd Rosenbluth, head of research at ETF Trends and ETF Database, said. “While in general earnings season has been strong for S&P 500 Index companies, some mega-cap companies have missed investor expectations. Equally weighted sector ETFs spread the risk around and will benefit more from secular trends.”
The equal-weight versions of the S&P 500 Information Technology, Communication Services, and Consumer Discretionary sectors are all outperforming their capitalization-weighted equivalents in April, with excess returns of 2%, 4%, and 5%, respectively, according to S&P Dow Jones Indices.
The S&P 500 Equal Weight Index outperformed the S&P 500 by 2% in Q1, according to S&P Dow Jones Indices U.S. Equal Weight Sector Dashboard.
The simple arithmetic of rebalancing connects equally weighted indexes to momentum effects. If the price of a constituent increases by more than the average of its peers, then its weight in the portfolio will increase, and the position will necessarily be trimmed at the next rebalance as the portfolio returns to equal weights, according to S&P Dow Jones Indices.
On the other hand, if a stock falls by more than the average of its peers, its weighting will fall too — and more must be purchased at the next rebalance to return to equal weight. Thus, equal-weight indexes sell relative winners and purchase relative losers at each rebalance.
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