Equal-Weighted Indexes Are Winning
- Posted by JC Parets
- on January 20th, 2013
It’s important to understand how our favorite averages are being computed. Some are Cap-weighted like the S&P500 and others are price weighted like the Dow Jones Industrial Average. I always find it funny that $IBM is over 20 times more important for the Dow than Alcoa ($AA) only because one is $190/share and the other is just $9. But the averages doing the best during this bull market are neither one of these. The winners here are the Equal-weighted averages that give each stock in the index the same value.
Last month we pointed to the Nasdaq100 Equal Weight Index making new highs, while its Cap-weighted counterpart ($QQQ) was being held back by the bear market in $AAPL. Pull up the charts, nothing’s changed since that post. Just higher highs from the Equal Weight Index and more underperformance out of Apple and the Triple QQQs.
I have long been a cheerleader for equal weighted indexes versus cap-weighted ones, and now seems like a good time to demonstrate why. In a cap-weighted index stocks influence the price of the index based upon their market capitalization (price time number of shares). For example the top 50 stocks in the S&P 500 Index represent about 70% of the index value, with the remaining 450 stocks providing only 30%. With an equal-weighted index all stocks carry the same weight — all the horses are pulling the wagon.
Below is a chart of the Guggenheim (formerly Rydex) S&P500 Equal Weight ETF. Look at the Equal Weight taking out and pushing beyond its 2007 highs while the $SPX continues to trade well below it. According to Swenlin, the S&P500 is up 114% from its 2009 lows. Meanwhile, the Equal Weighted version is up 175% during the same period. The 3rd chart below shows the relative performance between the two ($RSP:$SPX) since 1999:
Swenlin makes a good point in that the Equal Weighted Averages may not always be the best choice as they tend to move faster to the downside than their Cap-weighted counterparts. But in Bull markets, they clearly deserve some close consideration. I think this chart above shows that well.
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J.C. Parets is the Founder & President of Eagle Bay Capital, LLC. He earned the Chartered Market Technician designation (CMT) in 2008 and now actively manages money incorporating Technical Analysis and Behavioral Finance into his practice More
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