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Political Influences on Stock Valuation Levels

Do political factors influence stock valuation levels? In his July 2007 paper entitled “Can Political Factors Explain the Behavior of Stock Prices Beyond the Standard Present Value Models?”, Tomasz Wisniewski explores the degree to which political factors affect valuation of U.S. equities. Specifically, he examines whether party holding the Presidency (12 presidencies), Presidential approval ratings and timing of eight major military conflicts affect stock price levels relative to rational valuation models. Using data from a variety of sources for the period 1945-2005, he concludes that: Keep Reading

Naive Investors: Illusions of Personal Past Performance

Do individuals understand their actual aggregate investing/trading performance? In their July 2007 paper entitled “Why Inexperienced Investors Do Not Learn: They Don’t Know Their Past Portfolio Performance”, Markus Glaser and Martin Weber measure whether individual investors can correctly estimate personal absolute and relative stock portfolio performance. Using the responses of 215 online investors to a 2001 internet survey and actual portfolio returns for these investors during 1997-2000 as calculated from their holdings during that period, they find that: Keep Reading

Australian Stock Market Anomalies

Are anomalies observed with varying and changing levels of confidence among U.S. stocks, such as the size effect and the value premium, evident among stocks of other countries? In their recent paper entitled “Anomalies and Stock Returns: Australian Evidence”, Philip Gharghori, Ronald Lee and Madhu Veeraraghavan test for the existence among Australian stocks of a size effect, book-to-market effect, earnings-to-price (E/P) effect, cash flow-to-price (C/P) effect, leverage (debt-to-equity) effect and liquidity (share turnover) effect. Using stock price data for 1/92-12/05 and associated accounting data for 1/92-12/04, they conclude that: Keep Reading

The Truly Active Part of Active Fund Management

In his May 2007 paper entitled “Where Do Alphas Come From?: A New Measure of the Value of Active Investment Management”, Andrew Lo proposes a decomposition of the economic value of a fund’s management into two components, one measuring security selection (a weighted average of portfolio asset returns) and the other measuring timing (the correlation between portfolio asset weights and asset returns). When correlation between portfolio weights and returns is positive, management is moving assets toward optimization of overall portfolio returns. In other words, a manager can add value by: (1) picking the right assets; and, (2) continually growing positions with the highest future returns and shrinking positions with the lowest future returns. Using multiple examples, he argues that: Keep Reading

(Low) Volatility as an Indicator of Persistent Hedge Fund Outperformance

Market conditions vary considerably across the business cycle, presumably affecting the opportunity set for a given investing style/strategy. What are the return characteristics that predict which hedge funds can best navigate changing economic conditions? In his 2007 paper entitled “The Sustainability of Hedge Fund Performance: New Insights”, Daniel Capocci decomposes hedge fund returns to determine how investors can reliably identify funds that outperform equity and bond indexes in both bull and bear markets. Using monthly return data for the 1994-2002 business cycle from two sources (3,060 individual funds and 907 funds of funds) to investigate 14 potentially useful persistence discriminators, he concludes that: Keep Reading

Short-term Relative VIX Level as a Trading Signal

A reader requested a test of the TradingMarkets 5% VIX rule, which states:

“Do not buy stocks (or the market) anytime the VIX is 5% below its moving average. Why? Because since 1989, the S&P 500 cash market has “lost” money on a net basis 5 days following the times the VIX has been 5% below its 10 day ma.”

“Since 1989, whenever the VIX has been 5% or more above its 10 day ma, the S&P 500 has achieved returns which are better than 2 1/2 to 1 compared to the average weekly returns of all weeks.”

The reader also asked whether one can improve the signal by using a 4% or 6% threshold rather than 5%, or by using a holding interval longer or shorter than five days. We first reproduce the results claimed by TradingMarkets, then investigate whether the signals are of economic value to traders, and finally test sensitivity of results to parameter changes. Using daily CBOE Volatility Index (VIX) and S&P 500 index data for 1/2/90-7/11/07 (4415 trading days), we find that: Keep Reading

Professional Economists Forecasting Stock Returns

Via the semiannual Livingston Survey, the Federal Reserve Bank of Philadelphia solicits forecasts for the S&P 500 index (and many other U.S. economic measures) from economists in industry, government, banking and academia. How good are their forecasts? In his June 2007 paper entitled “Predicting Stock Price Movements: Regressions versus Economists”, Paul Soderlind examines the aggregate stock return forecasting ability of surveyed experts. Using median forecasts for stock market gains during the interval 6-12 months after survey dates and associated actual data for 1952-2005, he concludes that: Keep Reading

Multi-year Reversals for Past Winners and Losers

Are multi-year runs of bad (good) performance by individual stocks indicative of future returns? In other words, does the long-run behavior of stocks on average persist, reverse or fade to random? In their October 2006 paper entitled “Return Reversal in UK Shares”, Glen Arnold and Rose Baker examine the magnitude, persistence and source of reversals for UK stock returns. Using monthly total return and associated fundamentals data for stocks listed on the London Stock Exchange over the prior five calendar years during 1975-2002 (48 years), they find that: Keep Reading

When the Going Gets Tough, the Predictive Power Gets Going?

When times are good, the powers that be (central banks for interest rates and corporate boards for payouts to shareholders) have more latitude to buffer reactions to changes in the business environment. Does this latitude make widely used indicators of future stock returns less useful, or useless, during expansions? In their June 2007 draft paper entitled “Short-Horizon Predictability and Information Erosion”, Sam James Henkel, Spencer Martin and Federico Nardari investigate how the predictability of equity market returns varies across the business cycle. They focus on the dividend yield, the short-term interest rate, the slope of the term structure and the default premium as predictors of stock returns. Using monthly data spanning April 1953 to December 2005 for the U.S. (634 months) and comparable data as available for Canada, France, Germany, Italy, Japan and the UK, they find that: Keep Reading

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