How You Should Think About Benchmarks

I can't tell you how many times in my lifetime I've heard people who are managing against a benchmark like the S&P 500 or whatever it is, seeing a different part of the world doing better than their part of the world, and thinking they should switch benchmark to the better part of the world. Now, I'm just going to tell you, I don't think that's the right way to think about it. If you went back to the year 2000, we'd had a long period where Tech had done better than the S&P 500, and a lot of people said, "Gee, my benchmark should be the Nasdaq now." And in retrospect, obviously, that was stupid. But at the time they didn't think it was. Now, because after all, as they said at the time—and if you're old enough, you remember very well people saying, "It's the internet, stupid." The fact is, now you have a lot of people, because the US has done better than non-US, that have said things like, "The world is a benchmark you shouldn't have because the S&P 500 does better." Again, I think that's the wrong way to think about it. Let me help you dissect that a little bit so you can see a better way to think about it. 

The S&P 500, like any other index, has its own makeup based on what's in America. And a non-US world has its own sectoral makeup based on what's in the non-US world. The right way to think about it is, did the categories that are not overweight compared to the world do better or worse than comparable categories outside of America? I'm using the S&P 500 versus the world example. If you look at the major difference between the S&P 500 and the non-US world, it is overwhelmingly Tech and Tech-like stocks. Which Tech, basically to a rounding error, comes from America—doesn't come from other places. Other countries have a little bit of Tech or none. There is no other. I mean Taiwan, for its size, has a lot of Tech, but if you actually look at the world as a whole, Tech is America. Is Tech going to do better in the next five years than non-Tech? Well, that's a speculation. If it is, because Tech is a huge part of the S&P 500—basically almost 30%—then, yeah, the S&P 500 is going to do better. But the real question is not that. The real question is, the categories that exist in the United States and outside the United States—are the US ones doing better? And there the answer is, you can't really tell because they're so close together. But by having both, you have more diversity to choose from; you have more options.

If you think of categories like Materials companies. If you think of categories like Energy, if you think of categories like banking, which is a ubiquitous—not ubiquitous, but almost ubiquitous—global feature. You say, do the US ones do better or worse? And the answer is, some of them do a little better and some of them do a little worse, but outside of Tech and Tech-like, which would include things like the Telecommunication Services stocks, mostly they're the same. So, the benchmark against the world leads you back to the conclusion of where do I want to overweight and where do I want to underweight? But if I think of the global benchmark, I get a much bigger menu to choose from, and that's the reason why it makes more sense to think globally. 

Fundamentally, the global concept of a benchmark starts from the concept, which people used to say a lot and they don't say so much anymore, which is, think global first. And that comes down to things like, does American utilities do better than non-American utilities? Do American chemical companies do better than non-American chemical companies? When you get away from Tech, you find out that it's all pretty similar. And the difference between the S&P 500 and the non-US world is basically driven by Tech and Tech-like stocks. So, think through again, my original point about the year 2000 and the so-called "Tech bubble." And a lot of people telling you now that Tech is ahead of its skis—is it? Well, I don't want to go there. But if it is, and Tech underperforms because of its big weight, you shift it to an S&P 500 benchmark, you're going to get killed; real simple. If Tech does terribly, if Tech and Tech-like does terribly in the next five years, the S&P 500 is going to lag big time. Your goal is not to chase heat; your goal is to think about how do I do well and find a broad menu to do it by? And when you do that, you say to yourself, you want to weight against the world, the world has Tech in it. And then you have to make decisions. Do you underweight, or do you overweight? Every one of these categories. And if you're right, you win, and if you're wrong, you lose. And that's just the way the whole thing works. But when you move away from Tech and Tech-like, US stocks do not perform very differently in recent years than non-US stocks. So, therefore, you find yourself into this conundrum. 

Thank you for listening to me. I hope you found this educational and somewhat enjoyable. Appreciate it. Take care.