Something that can be pretty frustrating for traders is when you're watching your "stocks" position in whatever you are trading react worse than other stock indexes that you're not holding. For example if you're holding the MDY and it's down on the day, but you look over and see that the SPY isn't down as bad. Or you're making money on the MDY, but the QQQ is doing even better. It can be really frustrating.
The reason it happens is because all broad stock indexes move differently in different environments. Now there's definitely a strong directional correlation and they more or less go up and down together over the medium term, but the magnitude of the moves can be quite different at times on the very short term day to day.
To personalize it to us at VTS, we're going to compare the S&P 400 MidCap ETF called MDY, with the S&P 500 large cap ETF called SPY. Let's compare the performance of the two since July 2006.
We can see the S&P 400 MDY was actually outperforming the SPY over the first 13 years of this comparison. It's only in the last year or so that the SPY has overtaken the MDY.
The reason for this is the great run that some of the biggest tech companies have had in the last couple years, which are held within the SPY but not the MDY. We can see the 10 biggest holdings of both of these ETFs and it's pretty clear why the SPY has caught up to the MDY.
10 largest holdings of the S&P 500 (SPY)
10 largest holdings of the S&P 400 MidCap (MDY)
Quite a big difference there. The 10 largest in the SPY are very familiar names like Apple, Amazon, Facebook, Google, and they also make up nearly 28% of the S&P 500. Although the S&P 500 is about 500 companies in the index (technically 505) it's really the top 10 holdings that is pushing the price.
The top 10 holdings in the MDY only make up about 7% of the index, and they are names that very few people have probably even heard of. The mid cap stocks don't have nearly the reputation or news coverage of the big dogs.
This is why there can be day to day differences in how the MDY and the SPY move around. If tech is having a good day, the SPY will outperform MDY. If it's a poor day for tech then MDY will do better. Long term they do track well and it's a very close race between them. Short term though, it's really up to those big tech stocks as too which will win the day.
All we care about is how they trade in our strategies
So as we can see in the chart above, the SPY has actually overtaken the MDY and is slightly ahead in the race since 2006. However, if you look closely at that chart you'll notice that the spots where the good and bad performance is coming from is slightly different.
Do you notice that MDY seems to do worse during market crashes?
The red line in the chart for MDY builds up a lead, and then crashes down and nearly touches the blue line for SPY. This pattern has been fairly consistent, with MDY doing a little better most of the time, and crashing a little harder during sell offs.
The Tactical Balanced strategy rotates out of stocks and into safety positions during market sell offs, so we don't care that MDY crashes harder do we? We're not holding it when it's crashing. At that point we're in IEF bonds or GLD gold.
This is showing only the times we are holding MDY within the Tactical Balanced strategy vs what it would be if we replaced them for SPY.
Again, SPY is catching up in recent years due to the very frothy tech stock valuations of late, but overall the Tactical Balanced strategy has still done better using the S&P 400 MidCap MDY.
Due to the natural short term differences in stock indexes, I do use a variety in our family of tactical rotation strategies.
- Tactical Balanced strategy uses S&P 400 MidCap MDY
- VB Threshold strategy uses S&P 500 SPY
- Defensive Rotation strategy uses Vanguard Dividend VIG
- Breakpoint strategy uses the Nasdaq 100 QQQ
* Since the Breakpoint strategy doesn't really fit into the diversified portfolio right now (fairly redundant) and isn't represented at all for us, I will soon be switching the holdings of the Defensive Rotation strategy to the QQQ so we have more tech exposure and can cover the MDY, SPY and QQQ in our Total Portfolio Solution. Stay tuned for that change very soon.
The point is though, small day to day differences do exist between the various stock index ETFs out there. It's due to the composition of their holdings and how those heavier weighted allocations move around in different environments. The best thing to do is just have exposure to a few of them at the same time, and then not worry so much about what one of them is doing vs the others. Long term, if we have exposure to all of them then it'll average out in the end.