Replacing market indices

If equity markets suddenly sprang into existence now, would we create market indices? I’m doubtful.

Why an index?

The Dow Jones Industrial Average was born in 1896.  This was when computers were humans with adding machines (but they did do parallel processing).  At that point boiling “the market” down to a single number had value.

The two main uses of a market index are:

  • general sense of market direction
  • benchmark for a fund

Why not an index?

Now “computer” has a new meaning.  We don’t have to rely on 19th century solutions.

The market is not one-dimensional — a single number is not an adequate description.

Using an index as a performance benchmark is effectively useless.  It works if you have decades of information on the fund and you are willing to assume that the skill of the fund is constant throughout those decades.  The alternative is random portfolios which can be used to get coherent performance measurement.

Better than an index

If you are after description, then better than a number is a picture.  Perhaps like Figure 1.

Figure 1: S&P 500 constituents on 2011 December 30. Figure 1 was the last trading day of 2011, Figure 2 is the first trading day.

Figure 2: S&P 500 constituents on 2011 January 03.

Of course, you can use any time frame that you like.  Figure 3 is for all of 2011.

Figure 3: S&P 500 constituents in 2011. The returns in Figures 1 through 3 are simple returns.  For the daily returns, the difference between simple and log returns is minimal.  But it matters for the annual returns as can be seen in Figure 4.

Figure 4: S&P 500 constituents in 2011 with logarithmic returns.

Questions

What other uses of indices are there?

How can the plot be improved?

Update (2012 May 20):

Now the quartiles are indicated in gold on the axis.  The middle half of the data are inside the gold bars.  The distance between the gold bars is also stated as the interquartile range.

Update (2012 April):

The idea of a commentator has been taken up, and the fractions of postive returns and of negative returns are stated.

Update: Weekly market portraits are now produced for the US.

Appendix R

The R function that drew the figures is pp.marketdistrib — its definition is in pp.marketdistrib.R

getting the function

The easiest way to get the function is to start R and then do the command:

source("http://www.portfolioprobe.com/R/blog/pp.marketdistrib.R")

identifying assets

The main argument to the function is a vector of the returns of the assets.  If that vector has names, then the function allows you to identify the extreme assets with the ident argument.  The flexibility of R lists allows the possibility of easily stating how to arrange the labels so they don’t overwrite each other.

The labels for Figure 2 are easy since there is no overwriting.  We don’t need to use a list in this case, just a length two numeric vector saying how many we want labelled on each side — one in both cases here:

ident=c(1,1)

Figure 3 is more complex: we want no labels on the downside and two labels on the upside — but they would collide with each other if they were written on the same line:

ident=list(NULL, list(1,2))

Figure 1 is the most complex: we want to write more than one label on the same line plus others:

ident=list(list(1, 2), list(1:2, 3, 4))

Subscribe to the Portfolio Probe blog by Email

This entry was posted in Fund management in general, Market portrait, R language and tagged , , . Bookmark the permalink.

89 Responses to Replacing market indices

  1. st0ckthief says:

    You should change the x-axis scale to logarithmic in Fig. 4, because it appears like there are stocks that had a return of below -100%.

    A scale on the y-axis would be nice (percentage, absolute numbers).

    One way to improve the plot would be to calculate the area-under-the-curve of both the return>0 and return<0 sides, and chart this over time.

    • Pat says:

      st0ckthief,

      Thanks for the suggestion of stating the percent assets with negative/positive returns. I’ll probably experiment with that.

      Log returns can be less than -100% — they go to negative infinity. That is one of the reasons that log returns are more common in mathematical models than are simple returns.

      I had to work to get rid of the numbers on the y-axis (this is R, so it wasn’t much work). I think they are a distraction rather than an aid.

  2. Pingback: Monday links: what are indices good for? | Abnormal Returns

  3. Capital markets guy says:

    The missing link with indices has always been the lack of valuation signals and portfolio construction in the index. We’d replace indices with “strategy indices” that calculate the return to, for example, stocks with low book to market ratios.

    • Pat says:

      Capital markets guy,

      It seems to me like you are talking about fundamental indices. Perhaps we would do that, but I don’t think we should. When you create an index, you throw away the dispersion of the strategy.

      Much better, I think, is to create a set of random portfolios that follow the strategy and then show the distribution of their returns (similar to the plots in this post).

  4. Pingback: US market portrait 2012 weeks 38 and 39 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  5. Pingback: US market portrait 2012 week 49 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  6. Pingback: US market portrait 2012 week 45 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  7. Pingback: US market portrait 2012 final | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  8. Pingback: US market portrait 2012 week 24 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  9. Pingback: US market portrait 2013 week 9 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  10. Pingback: US market portrait 2012 week 17 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  11. Pingback: US market portrait 2012 week 18 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  12. Pingback: US market portrait 2012 week 19 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  13. Pingback: US market portrait 2012 week 21 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  14. Pingback: US market portrait 2012 week 27 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  15. Pingback: US market portrait 2012 week 30 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  16. Pingback: US market portrait 2012 week 31 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  17. Pingback: US market portrait 2012 week 32 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  18. Pingback: US market portrait 2012 week 33 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  19. Pingback: US market portrait 2012 week 36 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  20. Pingback: US market portrait 2012 week 37 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  21. Pingback: US market portrait 2012 week 40 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  22. Pingback: US market portrait 2012 week 42 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  23. Pingback: US market portrait 2012 week 43 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  24. Pingback: US market portrait 2012 week 46 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  25. Pingback: US market portrait 2012 week 47 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  26. Pingback: US market portrait 2012 week 48 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  27. Pingback: US market portrait 2012 week 51 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  28. Pingback: US market portrait 2012 week 52 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  29. Pingback: US market portrait 2013 week 1 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  30. Pingback: US market portrait 2013 week 8 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  31. Pingback: US market portrait 2013 week 15 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  32. Pingback: US market portrait 2013 week 16 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  33. Pingback: US market portrait 2013 week 27 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  34. Pingback: US market portrait 2013 week 32 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  35. Pingback: US market portrait 2013 week 37 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  36. Pingback: On smart beta | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  37. Pingback: US market portrait 2013 week 43 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  38. Pingback: US market portrait 2013 week 46 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  39. Pingback: US market portrait 2013 week 51 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  40. Pingback: S&P that might have been | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  41. Pingback: US market portrait 2014 week 2 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  42. Pingback: US market portrait 2014 week 3 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  43. Pingback: US market portrait 2014 week 4 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  44. Pingback: US market portrait 2014 week 5 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  45. Pingback: US market portrait 2014 week 6 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  46. Pingback: US market portrait 2014 week 7 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  47. Pingback: US market portrait 2014 week 8 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  48. Pingback: US market portrait 2014 week 10 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  49. Pingback: US market portrait 2014 week 11 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  50. Pingback: US market portrait 2014 week 12 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  51. Pingback: US market portrait 2014 week 13 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  52. Pingback: US market portrait 2014 week 14 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  53. Pingback: US market portrait 2014 week 15 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  54. Pingback: US market portrait 2014 week 16 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  55. Pingback: US market update 2014 week 17 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  56. Pingback: US market portrait 2014 week 18 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  57. Pingback: US market portrait 2014 week 19 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  58. Pingback: US market portrait 2014 week 20 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  59. Pingback: US market portrait 2014 week 21 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  60. Pingback: US market portrait 2014 week 22 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  61. Pingback: US market portrait 2014 week 23 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  62. Pingback: US market portrait 2014 week 24 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  63. Pingback: US market portrait 2014 week 25 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  64. Pingback: US market portrait 2014 week 26 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  65. Pingback: US market portrait 2014 week 27 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  66. Pingback: US market portrait 2014 week 28 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  67. Pingback: US market portrait 2014 week 29 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  68. Pingback: US market portrait 2014 week 32 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  69. Pingback: US market portrait 2014 week 33 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  70. Pingback: US market portrait 2014 week 34 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  71. Pingback: US market portrait 2014 week 35 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  72. Pingback: US market portrait 2014 week 36 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  73. Pingback: US market portrait 2014 week 37 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  74. Pingback: US market portrait 2014 week 38 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  75. Pingback: US market portrait 2014 week 39 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  76. Pingback: US market portrait 2014 week 40 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  77. Pingback: US market portrait 2014 week 41 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  78. Pingback: US market portrait 2014 week 42 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  79. Pingback: US market portrait 2014 week 43 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  80. Pingback: US market portrait 2014 week 44 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  81. Pingback: US market portrait 2014 week 45 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  82. Pingback: US market portrait 2014 week 46 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  83. Pingback: US market portrait 2014 week 47 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  84. Pingback: US market portrait 2014 week 48 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  85. Pingback: US market portrait 2014 week 49 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  86. Pingback: US market portrait 2014 week 50 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

  87. Pingback: US market portrait 2014 week 51 | Portfolio Probe | Generate random portfolios. Fund management software by Burns Statistics

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>