Did Russell 2000 Outperform S&P 500 in 2019?

        Intended for New Graduates

(Click on the image to enlarge)

Emily, a new graduate with co-concentrations (Econ & Finance), is interviewing for Equity Analyst position. 

Question # 1
Interviewer: Explain to us the basic difference between these two indices. 

Emily: While the S&P 500 index measures the performance of 500 large-cap stocks, the Russell 2000 index measures the performance of 2000 small-cap stocks. S&P 500 is the most widely followed stock market index.

Question # 2
Interviewer: Is there a market definition of large-cap stock? Also, can you name a few large caps?

Emily: Typically, a large-cap company has a market value of at least $10 Billion. Microsoft, Apple, Amazon, Google and Facebook are examples of large-caps. 

Question # 3
Interviewer: Can S&P 500 include one such large-cap stock that is listed on Nikkei only?

Emily: No. S&P 500 comprises large-cap stocks that are listed on US Exchanges.     

Question # 4
Interviewer: The data table shows S&P 500 has higher volatility than Russell's. What "quick" metric did we use to arrive at these volatility figures? And why?

Emily: I believe the quick metric you used is the Coefficient of Variation (commonly known by its short form COV). COV is the ratio of standard deviation to mean. Since you are making inter-index comparisons, you used the "normalized" metric. 

Question # 5
Interviewer: By glossing over these two graphs, do you notice any similarity?

Emily: Yes, between August and December, they both produced linear growth. Spectacular growth, indeed!

Question # 6
Interviewer: Any striking dissimilarity, per se?

Emily: Yes, the correction in August was way more pronounced for Russell than that of S&P's. 

Question # 7
Interviewer: By looking at the data table, can you tell us how S&P outperformed Russell in terms of overall growth?

Emily: Because S&P produced 8% growth between January and August, whereas Russell remained on a slippery slope, failing to hang on to its gains. 

Question # 8
Interviewer: To take advantage of these indices, what investment vehicles would you recommend to our clients?

Emily: Index Funds, Index ETFs, S&P Futures and Options, etc.

Question # 9
Interviewer: Of these two indices, which one would you recommend to our conservative clients? Or, would you recommend both?

Emily: Russell 2000 would not be appropriate for them.

Good Luck!

-Sid Som, MBA, MIM
President, Homequant
homequant@gmail.com

                     Link to the Book

Nikkei 225 vs. S&P 500 – Are They Correlated?

(Click on the image to enlarge)

Muhammad is interviewing for the Market Data Analyst position. 

Question # 1
Interviewer: The above graphics comprise the daily closing data between July 1, 2018 and July 31, 2019. Are you familiar with these two indices?

Muhammad: Yes, I work with them quite frequently. S&P 500 is our broader market index, while the Nikkei 225 is the Japanese counterpart. 

Question # 2
Interviewer: Would you say these two indices are highly correlated? Qualify your answer with the appropriate statistic.

Muhammad: No. They have low to moderate correlation depending on the statistic you consider. Based on the correlation coefficient, they have moderate correlation, whereas the two regression r-squared(s) are demonstrating lower correlations. 

Question # 3
Interviewer: Considering Nikkei's significantly higher standard deviation, would you say it is more volatile than the S&P 500?

Muhammad: No. The standard deviations are not directly comparable because the underlying data values are significantly different. In fact, the graph axes show how different they are.

Question # 4
Interviewer: Given these statistics, how would you characterize the relative volatility here? 

Muhammad: Since the coefficient of variation is a normalized statistic (standard deviation divided by average), it is a better statistical indicator of the market volatility. Thus, Nikkei was slightly less volatile than the S&P 500 during this period.

Question # 5
Interviewer: If you are asked to establish a better correlation between these two markets, what would you do?

Muhammad: Instead of 13 months' worth of data, I would use a more extended data series, perhaps going back five to six years, thus smoothing out the scatter, resulting in more meaningful correlation statistics.

Question # 6
Interviewer: How did you decide on five to six years, rather than a longer series?

Muhammad: I used five to six years, to avoid having to pick any data from the bottom of the last recession. The real recovery started about six years ago so the last five to six years would provide more normal data.

Question # 7
Interviewer: By extending the series to five to six years, you will be introducing more noise and volatility. How is that statistically more prudent?

Muhammad: I will switch from the daily closings to weekly closings which are inherently smoother and less volatile. Weekly closings are more modelable as well.
  
Question # 8
Interviewer: The left header of the top graphic says "Statistics." Is that accurate?

Muhammad: Yes. Statistics are derived from samples, while parameters are extracted from the entire population. In this case, you are working out of a 13-month sample.

Question # 9
Interviewer: We have openings in both stock fund and index fund units. If you are allowed to choose, which one would you opt for and why?

Muhammad: Definitely the stock fund. It would be lot more challenging. I will get to research the entire sector, narrow my choices down and make recommendations on my final selections. I am looking forward to a challenging job like that.

Disclaimer - The author is not advocating the indices listed here. Consult your Registered Rep, RIA or Financial Planner for an appropriate asset allocation model and the suitability of stocks, indices and other holdings for your portfolio.

Good Luck!

Sid Som, MBA, MIM
President, Homequant, Inc.
homequant@gmail.com

Link to the Book
How to Solve Complex Data Problems in a Job Interview (20 Live Simulations with actual Market Data)