Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for September 2020 (Final)

Momentum Investing Strategy (Strategy Overview)

Allocations for September 2020 (Final)
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Bonds have two price components, yield and response of price to prevailing interest rates. How much of a return premium should investors in bonds expect? How can investors enhance this premium? These blog entries examine investing in bonds.

Evaluating Country Investment Risk

How should global investors assess country sovereign bond and equity risks? In his July 2020 paper entitled “Country Risk: Determinants, Measures and Implications – The 2020 Edition”, Aswath Damodaran examines country risk from multiple perspectives. To estimate a country risk premium, he considers measurements of both country government bond risk and country equity risk. Based on a variety of sources and methods, he concludes that: Keep Reading

SACEVS Input Risk Premiums and EFFR

The “Simple Asset Class ETF Value Strategy” (SACEVS) seeks diversification across a small set of asset class exchanged-traded funds (ETF), plus a monthly tactical edge from potential undervaluation of three risk premiums:

  1. Term – monthly difference between the 10-year Constant Maturity U.S. Treasury note (T-note) yield and the 3-month Constant Maturity U.S. Treasury bill (T-bill) yield.
  2. Credit – monthly difference between the Moody’s Seasoned Baa Corporate Bonds yield and the T-note yield.
  3. Equity – monthly difference between S&P 500 operating earnings yield and the T-note yield.

Premium valuations are relative to historical averages. How might this strategy react to changes in the Effective Federal Funds Rate (EFFR)? Using end-of-month values of the three risk premiums, EFFRtotal 12-month U.S. inflation and core 12-month U.S. inflation during March 1989 (limited by availability of operating earnings data) through July 2020, we find that: Keep Reading

Testing a Countercyclical Asset Allocation Strategy

“Countercyclical Asset Allocation Strategy” summarizes research on a simple countercyclical asset allocation strategy that systematically raises (lowers) the allocation to an asset class when its current aggregate allocation is relatively low (high). The underlying research is not specific on calculating portfolio allocations and returns. To corroborate findings, we use annual mutual fund and exchange-traded fund (ETF) allocations to stocks and bonds worldwide from the 2020 Investment Company Fact Book, Data Tables 3 and 11 to determine annual countercyclical allocations for stocks and bonds (ignoring allocations to money market funds). Specifically:

  • If actual aggregate mutual fund/ETF allocation to stocks in a given year is above (below) 60%, we set next-year portfolio allocation below (above) 60% by the same percentage.
  • If actual aggregate mutual fund/ETF allocation to bonds in a given year is above (below) 40%, we set next-year portfolio allocation below (above) 40% by the same percentage.

We then apply next-year allocations to stock (Fidelity Fund, FFIDX) and bond (Fidelity Investment Grade Bond Fund, FBNDX) mutual funds that have long histories. Based on Fact Book annual publication dates, we rebalance at the end of April each year. Using the specified actual fund allocations for 1984 through 2019 and FFIDX and FBNDX May through April total returns and April 1-year U.S. Treasury note (T-note) yields for 1985 through 2020, we find that: Keep Reading

Federal Reserve Treasuries Holdings and Asset Returns

Is the level, or changes in the level, of Federal Reserve (Fed) holdings of U.S. Treasuries (bills, notes, bonds and TIPS, measured weekly as of Wednesday) an indicator of future stock market and/or Treasuries returns? To investigate, we take dividend-adjusted SPDR S&P 500 (SPY) and iShares Barclays 20+ Year Treasury Bond (TLT) as tradable proxies for the U.S. stock and Treasuries markets, respectively. Using weekly Fed holdings of Treasuries, SPY and TLT during mid-December 2002 through early July 2020, we find that: Keep Reading

Ending with the Beginning in Mind

How should investors think about the interactions between working years (retirement account contributions) and retirement years (retirement account withdrawals)? In his June 2020 paper entitled “Retirement Planning: From Z to A”, Javier Estrada integrates working and retirement periods to estimate how much an individual should save and how they should invest to achieve a desired retirement income and ultimate bequest to heirs. He illustrates his analytical solution empirically for U.S. stocks and bonds, first using a base case plus sensitivity analysis and then using Monte Carlo simulations. His base case assumes:

  • Work will last 40 years with a 60%/40% stocks/bonds retirement portfolio.
  • Retirement will last 30 years with beginning-of-year real (inflation-adjusted) withdrawals of $60,000 from a 40%/60% stocks/bonds retirement portfolio and ultimate bequest $300,000.

Using annual data for U.S. stocks (the S&P 500 Index total return), bonds (10-year U.S. Treasury notes) and U.S. inflation during 1928 through 2019, he finds that: Keep Reading

Exploitable Government Bond Return Predictability?

Are government bond returns exploitably predictable? In their June 2020 paper entitled “Predicting Bond Returns: 70 Years of International Evidence”, Guido Baltussen, Martin Martens and Olaf Penninga examine predictability of international 10-year government bond returns with emphasis on two subsamples, January 1950 through September 1981 (mostly rising interest rates) and October 1981 through May 2019 (mostly falling rates). They consider five predictive variables, each transformed into a binary signal:

  1. Yield spread – 10-year government bond yield minus the cash rate, standardized relative to historical values.
  2. Bond trend – sign of past 12-month 10-year government bond return.
  3. Past equity return – past 12-month equity index return in excess of cash return, standardized relative to historical values.
  4. Past commodities return – past 12-month commodity index excess return, standardized relative to historical values.
  5. Combination – equal-weighted combination of signals 1 through 4.

They use a spliced 10-year government bond sample, using excess return on a representative bond index before inception of associated futures and futures returns thereafter. Using monthly returns for 10-year government bond indexes/futures and cash rates for Australia, Canada, Germany, Japan, UK and U.S. during January 1950 (except October 1961 for Japan) through May 2019 (7,497 monthly returns), they find that: Keep Reading

Smart Money Indicator Verification Update

“Verification Tests of the Smart Money Indicator” performs tests of ideas and setup features described in “Smart Money Indicator for Stocks vs. Bonds”. The Smart Money Indicator (SMI) is a complicated variable that exploits differences in futures and options positions in the S&P 500 Index, U.S. Treasury bonds and 10-year U.S. Treasury notes between institutional investors (smart money) and retail investors (dumb money) as published in Commodity Futures Trading Commission Commitments of Traders (COT) reports. Since findings for some variations in that test are attractive, we add two further robustness tests:

Using COT report data, dividend-adjusted SPDR S&P 500 (SPY) as a proxy for a stock market total return index, 3-month Treasury bill (T-bill) yield as return on cash (Cash) and dividend-adjusted iShares 20+ Year Treasury Bond (TLT) as a proxy for government bonds during 6/16/06 through 4/3/20, we find that:

Keep Reading

Bonds During the Off Season?

As implied in “Mirror Image Seasonality for Stocks and Treasuries?”, are bonds better than stocks during the “Sell-in-May” months of May through October? Are behaviors of government, corporate investment grade and corporate high-yield bonds over this interval similar? To investigate, we test seasonal behaviors of:

SPDR S&P 500 (SPY)
Vanguard Intermediate-Term Treasury (VFITX)
Fidelity Investment Grade Bond (FBNDX)
Vanguard High-Yield Corporate Bond (VWEHX)

Using dividend-adjusted monthly prices for these funds during January 1993 (limited by SPY) through January 2020, we find that: Keep Reading

Effects of Execution Delay on SACEVS

How does execution delay affect the performance of the Best Value and Weighted versions of the “Simple Asset Class ETF Value Strategy” (SACEVS)? These strategies each month allocate funds to the following asset class exchange-traded funds (ETF) according to valuations of term, credit and equity risk premiums, or to cash if no premiums are undervalued:

3-month Treasury bills (Cash)
iShares 20+ Year Treasury Bond (TLT)
iShares iBoxx $ Investment Grade Corporate Bond (LQD)
SPDR S&P 500 (SPY)

To investigate, we compare 22 variations of each strategy with execution days ranging from end-of-month (EOM) per the baseline strategy to 21 trading days after EOM (EOM+21). For example, an EOM+5 variation computes allocations based on EOM but delays execution until the close five trading days after EOM. We include a benchmark that each month allocates 60% to SPY and 40% to TLT (60-40) to see whether variations are unique to SACEVS. We focus on gross compound annual growth rate (CAGR), maximum drawdown (MaxDD) and annual Sharpe ratio as key performance statistics. Using daily dividend-adjusted closes for the above ETFs from the end of July 2002 through January 2020, we find that:

Keep Reading

Best Bear Market Asset Class?

A subscriber asked which asset (short stocks, cash, bonds by subclass) is best to hold during equity bear markets. To investigate, we consider two ways to define a bear market: (1) months when SPDR S&P 500 (SPY) is below its 10-month simple moving average (SMA10) at the end of the prior month; and, (2) months when SPY is in drawdown by at least 20% from a high-water mark at the end of the prior month. We consider nine alternative assets:

  1. Short SPY
  2. Cash, estimated using the yield on 3-month U.S. Treasury bills (T-bill)
  3. Vanguard GNMA Securities (VFIIX)
  4. T. Rowe Price International Bonds (RPIBX)
  5. Vanguard Long-Term Treasury Bonds (VUSTX)
  6. Fidelity Convertible Securities (FCVSX)
  7. T. Rowe Price High-Yield Bonds (PRHYX)
  8. Fidelity Select Gold Portfolio (FSAGX)
  9. Spot Gold

Specifically, we compare monthly return statistics, compound annual growth rates (CAGR) and maximum (peak-to-trough) drawdowns (MaxDD) of these nine alternatives during bear market months. Using monthly T-bill yield and monthly dividend-adjusted closing prices for the above assets during January 1993 (as limited by SPY) through Feb 2020, we find that: Keep Reading

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