Objective research to aid investing decisions
Menu
Value Allocations for August 2019 (Final)
Cash TLT LQD SPY
Momentum Allocations for August 2019 (Final)
1st ETF 2nd ETF 3rd ETF

Investing Research Articles

Best U.S. Equity Market Hedge Strategy?

What steps should investors consider to mitigate impact of inevitable large U.S. stock market corrections? In their May 2019 paper entitled “The Best of Strategies for the Worst of Times: Can Portfolios be Crisis Proofed?”, Campbell Harvey, Edward Hoyle, Sandy Rattray, Matthew Sargaison, Dan Taylor and Otto Van Hemert compare performances of an array of defensive strategies with focus on the eight worst drawdowns (deeper than -15%) and three NBER recessions during 1985 through 2018, including:

  1. Rolling near S&P 500 Index put options, measured via the CBOE S&P 500 PutWrite Index.
  2. Credit protection portfolio that is each day long (short) beta-adjusted returns of duration-matched U.S. Treasury futures (BofAML US Corp Master Total Return Index), scaled retrospectively to 10% full-sample volatility.
  3. 10-year U.S. Treasury notes (T-notes).
  4. Gold futures.
  5. Multi-class time-series (intrinsic or absolute) momentum portfolios applied to 50 futures contract series and reformed monthly, with:
    • Momentum measured for 1-month, 3-month and 12-month lookback intervals.
    • Risk adjustment by dividing momentum score by the standard deviation of security returns.
    • Risk allocations of 25% to currencies, 25% to equity indexes, 25% to bonds and 8.3% to each of agricultural products, energies and metals. Within each group, markets have equal risk allocations.
    • Overall scaling retrospectively to 10% full-sample volatility.
    • With or without long equity positions.
  6. Beta-neutral factor portfolios that are each day long (short) stocks of the highest (lowest) quality large-capitalization and mid-capitalization U.S. firms, based on profitability, growth, balance sheet safety and/or payout ratios.

They further test crash protection of varying allocations to the S&P 500 Index and a daily reformed hedge consisting of equal weights to: (1) a 3-month time series momentum component with no long equity positions and 0.7% annual trading frictions; and, (2) a quality factor component with 1.5% annual trading frictions. For this test, they scale retrospectively to 15% full-sample volatility. Throughout the paper, they assume cost of leverage is the risk-free rate. Using daily returns for the S&P 500 Index and inputs for the specified defensive strategies during 1985 through 2018, they find that:

Keep Reading

Weekly Summary of Research Findings: 6/17/19 – 6/21/19

Below is a weekly summary of our research findings for 6/17/19 through 6/21/19. These summaries give you a quick snapshot of our content the past week so that you can quickly decide what’s relevant to your investing needs.

Subscribers: To receive these weekly digests via email, click here to sign up for our mailing list. Keep Reading

Stock Market Behavior Around Mid-year and 4th of July

The middle of the year might be a time for funds to dress their windows and investors to review and revise portfolios. The 4th of July celebration might engender optimism among U.S. investors. Are there any reliable patterns to daily U.S. stock market returns around mid-year and the 4th of July? To check, we analyze the historical behavior of the S&P 500 Index from five trading days before through trading days after both the end of June and the 4th of July. Using daily closing levels of the index for 1950-2018 (69 years), we find that: Keep Reading

Best Equity Risk Premium

What are the different ways of estimating the equity risk premium, and which one is best? In his April 2019 paper entitled “Equity Risk Premiums (ERP): Determinants, Estimation and Implications – The 2019 Edition”, Aswath Damodaran updates a comprehensive overview of equity risk premium estimation and application. He examines why different approaches to estimating the premium disagree and how to choose among them. Using data from multiple countries (but focusing on the U.S.) over long periods through the end of 2018, he concludes that: Keep Reading

SACEMS with Different Alternatives for “Cash”

Do alternative “Cash” (deemed risk-free) instruments materially affect performance of the “Simple Asset Class ETF Momentum Strategy” (SACEMS)? Changing the proxy for Cash can affect how often the model selects Cash, as well as the return on Cash when selected. To investigate, we test separately each of the following yield and exchange-traded funds (ETF) as the risk-free asset:

3-month Treasury bills (Cash), a proxy for the money market as in base SACEMS
SPDR Bloomberg Barclays 1-3 Month T-Bill (BIL)
iShares 1-3 Year Treasury Bond (SHY)
iShares 7-10 Year Treasury Bond (IEF)
iShares TIPS Bond (TIP)

In other words, we add one of the five risk-free assets to the following base set of eight ETFs:

PowerShares DB Commodity Index Tracking (DBC)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI EAFE Index (EFA)
SPDR Gold Shares (GLD)
iShares Russell 2000 Index (IWM)
SPDR S&P 500 (SPY)
iShares Barclays 20+ Year Treasury Bond (TLT)
Vanguard REIT ETF (VNQ)

We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics and consider Top 1, equally weighted (EW) EW Top 2 and EW Top 3 SACEMS portfolios. Using end-of-month total (dividend-adjusted) returns for the specified assets during February 2006 (except May 2007 for BIL) through May 2019, we find that:

Keep Reading

ICO Performance Tendencies

Are Initial Coin Offerings (ICO), also called token sales or token offerings, typically good investments? ICOs are smart contracts on a blockchain (usually Ethereum) that enable firms to raise money directly from investors. The median time for listing a successful ICO on a token exchange is 42 days. In the May 2019 revision of his paper entitled “The Pricing and Performance of Cryptocurrency”, Paul Momtaz examines the performance of ICOs for horizons of one day to three years after initial listing. He also investigates whether there are robust predictors of initial pricing and longer term performance. His sample consists of all tokens tracked by coinmarketcap.com during January 2013 through April 2018, less confirmed errors and outliers in extreme 1% tails because they are unverifiable. His benchmark for calculating abnormal returns is the market capitalization-weighted return of cryptocurrencies (dominated by Bitcoin and Ethereum). Using daily high, low and closing prices, market capitalizations and trading volumes of 1,403 ICOs and daily closes of major cryptocurrencies during the specified period, he finds that: Keep Reading

KCFSI as a Stock Market Return Predictor

A subscriber suggested the Kansas City Financial Stress Index (KCFSI) as a potential U.S. stock market return predictor. This index “is a monthly measure of stress in the U.S. financial system based on 11 financial market variables. A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average. Another useful way to assess the current level of financial stress is to compare the index to its value during past, widely recognized episodes of financial stress.” The paper “Financial Stress: What Is It, How Can It Be Measured, and Why Does It Matter?” describes the 11 financial inputs for KCFSI and its methodology, which involves monthly demeaning of inputs, monthly normalization of the overall indicator to have historical standard deviation one and principal component analysis. This process changes past values in the series, perhaps even changing their signs. Is KCFSI useful for U.S. stock market investors? To investigate, we relate monthly S&P 500 Index returns to monthly values of, and changes in, KCFSI. Per the KCFSI release schedule, we use the market close on the first trading day of the month after the 7th for calculations. Using monthly data for KCFSI and the S&P 500 Index during February 1990 (limited by KCFSI) through May 2019, we find that: Keep Reading

Weekly Summary of Research Findings: 6/10/19 – 6/14/19

Below is a weekly summary of our research findings for 6/10/19 through 6/14/19. These summaries give you a quick snapshot of our content the past week so that you can quickly decide what’s relevant to your investing needs.

Subscribers: To receive these weekly digests via email, click here to sign up for our mailing list. Keep Reading

Exploiting Chicago Fed NFCI Predictive Power

“Chicago Fed NFCI as U.S. Stock Market Predictor” suggests that weekly change in the Federal Reserve Bank of Chicago’s National Financial Conditions Index (NFCI) may be a useful indicator of future U.S. stock market returns. We test its practical value via two strategies that are each week in SPDR S&P 500 (SPY) when prior change in NFCI is favorable and in cash (U.S. Treasury bills, T-bills) when prior change in NFCI is unfavorable, as follows:

  1. Change in NFCI < Mean [aggressive]: hold SPY (cash) when prior-week change in NFCI is below (above) its mean since inception in January 1971.
  2. Change in NFCI < Mean+SD [conservative]: hold SPY (cash) when prior-week change in NFCI is below (above) its mean plus one standard deviation of weekly changes in NFCI since inception in January 1971.

The return week is Wednesday open to Wednesday open (Thursday open when the market is not open on Wednesday) per the NFCI release schedule. We assume SPY-cash switching frictions are a constant 0.1% over the sample period. We use buying and holding SPY as the benchmark. Using weekly levels of NFCI as of May 2019 since January 1971 and weekly dividend-adjusted opens of SPY and T-bills since February 1993 (limited by SPY), all through May 2019, we find that: Keep Reading

Chicago Fed NFCI as U.S. Stock Market Predictor

A subscriber suggested that the Federal Reserve Bank of Chicago’s National Financial Conditions Index (NFCI) may be a useful U.S. stock market predictor. NFCI “provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and ‘shadow’ banking systems.” It consists of 105 inputs, including the S&P 500 Implied Volatility Index (VIX) and Senior Loan Officer Survey results. Positive (negative) values indicate tight (loose) financial conditions, with degree measured in standard deviations from the mean. The Chicago Fed releases NFCI each week as of Friday on the following Wednesday at 8:30 a.m. ET (or Thursday if Wednesday is a holiday), renormalized such that the full series always has a mean of zero and a standard deviation of one (thereby each week changing past values, perhaps even changing their signs). To investigate its usefulness as a U.S. stock market predictor, we relate NFCI and changes in NFCI to future S&P 500 Index returns. Using weekly levels of NFCI and weekly closes of the S&P 500 Index during January 1971 (limited by NFCI) through May 2019, we find that: Keep Reading

Daily Email Updates
Login
Research Categories
Recent Research
Popular Posts