The NT effect in the Index.I wanted to comment on indexes and how certain stocks can really lead an index in a direction which may not be that of the index or market. The article below from Reuters explains it fairly well.
Long on NHC! :)
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Wednesday October 25 2:17 PM ET
Nortel's Weight Distorts Key Canada Index - Analysts
By Ian Karleff
TORONTO (Reuters) - As the Toronto Stock Exchange's key 300 composite index plunged 935 points, or 10 percent, on Wednesday morning, fund managers said the much vaunted-benchmark is meaningless because of its excessive exposure to Nortel Networks Corp., and consequently its overexposure to volatile technology stocks.
Over the past decade, the TSE 300 has increasingly shed its focus on traditional Canadian natural resources issues and has become much more a technology index, dominated by Nortel.
In 1999, when Nortel stock was making startling advances, fund managers complained that because Nortel comprised upward of 30 percent of the TSE 300, they didn't stand a chance of beating the index because investment rules limited them to having no more than 10 percent of the book value of their funds in any one stock.
Now, those who remained cautiously underweight on Nortel in 2000 are poised to be vindicated, and substantially beat the index.
``The TSE 300 composite index is meaningless in this situation. It is telling us nothing other than the action of Nortel,'' said Gerald Vincent, portfolio manager and vice-president at Davis-Rea Ltd. Investment Counsel.
Nortel's shares dropped 26 percent on Wednesday after reporting earnings per share that beat analysts' estimates by one cent, but failed to show strong growth in revenues from fiber-optic equipment.
Nortel's plunge makes it glaringly clear, both on the upside and downside, that the TSE 300 is not a good judge of Canada's equity market performance, as Nortel's losses contributed to 90 percent of the overall drop in the index on Wednesday.
``There are serious benchmarking problems that the Nortel phenomenon has revealed because it's one of the few businesses in Canada that has achieved such a mammoth market cap and multiple,'' added Vincent.
One buy-side fund company analyst on Bay Street said ``it was frustrating as hell'' to stand by and watch his performance numbers suffer in 1999, not to mention watching his value-oriented peers lose their jobs on poor performance.
Douglas Porter, an economist at BMO Nesbitt Burns said that fund managers who have underperformed the TSE 300 for the past few years are going to find the opposite this year with Nortel killing the index's performance numbers.
``This is exactly why people were scrambling to try to find alternative indices to the TSE benchmark on which to judge performance,'' Porter said.
``We will find that a number of mutual funds are suddenly outperforming the TSE after today,'' said Porter, referring to fund managers who decided it wasn't prudent to carry a 35 percent holding in one company.
TSE NO BETTER THAN OTHER INDEXES
Nortel has given the TSE 300 incredible leverage over the past few years because of its disproportionate weighting, said Peter Chandler, senior vice-president at Canaccord Capital Corp.
``For the first time I can remember, the TSE was the strongest stock exchange in the western world, and you can largely put that on the back of Nortel,'' said Chandler.
But this leverage can go both ways, and Nortel's plunge on Wednesday proved that it can have a devastating effect when it drops.
And while the TSE 300 takes the rap for not representing Canada's true equity performance, other indexes that were recently created fare no better.
The TSE/S&P 60 index dropped by more than 10 percent on Wednesday, mainly because it is a market weighted index.
``Unfortunately, the TSE 60 has Nortel in it and it's a market weighted index, so as long as you have that mammoth market cap factor swinging up and down, Nortel is what you're measuring,'' said Vincent.
Vincent also pointed to the Standard & Poor's 500 index in New York as having a similar problem, albeit not quite so severe, with only 33 stocks making up 50 percent of its weighting.
GOVERNMENT PENSION PLAN BAILED EARLY
Meanwhile, the Canada Pension Plan Investment Board announced on Wednesday that its almost C$5 billion fund, which was investing 80 percent of its cash flow in a TSE 300 index tracking fund, sold down its Nortel position in September.
``Our Nortel position has served us well. Our decision to reduce our investment is based on a core principle of prudent risk management, namely to limit portfolio exposure to any single stock,'' said the investment board's chief executive, John MacNaughton.
In late August the pension plan was given regulatory approval to actively invest 50 percent of its Canadian equities, which resulted in it paring back its Nortel holdings to a 14 percent weighting from an earlier 25 percent.
Prior to the government ruling in August, the investment board said it basically mimicked the weighting of Nortel in the TSE 300 index.
($1-$1.52 Canadian)