Bonds

How should global investors assess country sovereign bond and equity risks? In his July 2023 paper entitled “Country Risk: Determinants, Measures and Implications – The 2023 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

What happens if we extend the “Simple Asset Class ETF Value Strategy” (SACEVS) with a real estate risk premium, derived from the yield on equity Real Estate Investment Trusts (REIT), represented by the FTSE NAREIT Equity REITs Index? To investigate, we apply the SACEVS methodology to the following asset class exchange-traded funds (ETF), plus cash:

3-month Treasury bills (Cash)
iShares 20+ Year Treasury Bond (TLT)
iShares iBoxx $ Investment Grade Corporate Bond (LQD)
SPDR Dow Jones REIT (RWR) through September 2004 dovetailed with Vanguard REIT ETF (VNQ) thereafter
SPDR S&P 500 (SPY)

This set of ETFs relates to four risk premiums, as specified below: (1) term; (2) credit (default); (3) real estate; and, (4) equity. We focus on effects of adding the real estate risk premium on gross compound annual growth rates (CAGR), maximum drawdowns (MaxDD) and annual Sharpe ratios of the Best Value (picking the most undervalued premium) and Weighted (weighting all undervalued premiums according to degree of undervaluation) versions of SACEVS. Using lagged quarterly S&P 500 earnings, monthly S&P 500 Index levels and monthly yields for 3-month U.S. Treasury bill (T-bill), the 10-year Constant Maturity U.S. Treasury note (T-note), Moody’s Seasoned Baa Corporate Bonds and FTSE NAREIT Equity REITs Index since March 1989 (limited by availability of earnings data), and monthly dividend-adjusted closing prices for the above asset class ETFs since July 2002, all through February 2023, we find that: Keep Reading

“Simplified Offensive, Defensive and Risk Mode Identification Momentum Strategy” describes a strategy that each month holds offensive (defensive) assets when average return on iShares TIPS Bond ETF (TIP) over the past 1, 3, 6 and 12 months is positive (negative). Is past return of TIP, which purely impounds investor expectations for U.S. inflation, a reliable indicator of future asset class returns? To investigate, we relate TIP returns to future returns for each of the following exchange-traded fund (ETF) asset class proxies:

• Equities:
  • SPDR S&P 500 (SPY)
  • iShares Russell 2000 Index (IWM)
  • iShares MSCI EAFE Index (EFA)
  • iShares MSCI Emerging Markets Index (EEM)
• Bonds:
  • iShares Barclays 20+ Year Treasury Bond (TLT)
  • iShares iBoxx $ Investment Grade Corporate Bond (LQD)
  • iShares JPMorgan Emerging Markets Bond Fund (EMB)
• Real assets:
  • Vanguard REIT ETF (VNQ)
  • SPDR Gold Shares (GLD)
  • Invesco DB Commodity Index Tracking (DBC)

We consider both linear correlation and non-linear ranking tests. We look at TIP returns over the past 1, 3, 6 and 12 months separately, and as an average of these past returns (average past TIP return). Using monthly dividend-adjusted returns for TIP and the above asset class proxies as available during December 2003 (limited by TIP) through February 2023, we find that: Keep Reading

Is there a way to restore/enhance the relevance to investors of the Fed model, which is based on a putative investor-driven positive relationship between stock market earnings yield (equity earnings-to-price ratio) and U.S. Treasury bond (10-year) yield? In his February 2023 paper entitled “The Fed Model: Is it Still With Us?”, David McMillan re-examines the predictive power of this relationship with the addition of regime shifts that may expose predictive power not persistent across the full sample. He considers three versions of the Fed model:

1. Fed1 – ratio of earnings yield to bond yield (yield ratio).
2. Fed2 – simple difference between earnings yield and bond yield (yield gap).
3. Fed3 – logarithmic version of Fed2 (log yield gap).

He tests the power of each model variation to predict stock market returns at horizons of 1, 3 and 12 months, either including or excluding earnings yield and the interest rate term structure (U.S. Treasury 10-year yield minus 3-month yield) as control variables. He considers two ways to detect regime shifts in each model variation: (1) regressing each series on a constant term and looking for a break in its value; and, (2) a Markov-switching approach. Using monthly S&P Composite index level and earnings, and 10-year and 3-month U.S. Treasury yields during January 1959 through December 2021, he finds that:

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How do returns of different asset classes recently interact with the Effective Federal Funds Rate (EFFR)? We focus on monthly changes (simple differences) in EFFR  and look at lead-lag relationships between change in EFFR and returns for each of the following 10 exchange-traded fund (ETF) asset class proxies:

• Equities:
  • SPDR S&P 500 (SPY)
  • iShares Russell 2000 Index (IWM)
  • iShares MSCI EAFE Index (EFA)
  • iShares MSCI Emerging Markets Index (EEM)
• Bonds:
  • iShares Barclays 20+ Year Treasury Bond (TLT)
  • iShares iBoxx $ Investment Grade Corporate Bond (LQD)
  • iShares JPMorgan Emerging Markets Bond Fund (EMB)
• Real assets:
  • Vanguard REIT ETF (VNQ)
  • SPDR Gold Shares (GLD)
  • Invesco DB Commodity Index Tracking (DBC)

Using monthly EFFR and monthly dividend-adjusted prices for the 10 ETFs during December 2007 (limited by EMB) through December 2022, we find that: Keep Reading

“Exploiting the Presidential Cycle and Party in Power” summarizes strategies that hold small stocks (large stock or bonds) when Democrats (Republicans) hold the U.S. presidency. How has this strategy performed in recent years? To investigate, we consider three strategy alternatives using exchange-traded funds (ETF):

1. D-IWM:R-SPY: hold iShares Russell 2000 (IWM) when Democrats hold the presidency and SPDR S&P 500 (SPY) when Republicans hold it.
2. D-IWM:R-LQD: hold IWM when Democrats hold the presidency and iShares iBoxx Investment Grade Corporate Bond (LQD) when Republicans hold it.
3. D-IWM:R-IEF: hold IWM when Democrats hold the presidency and iShares 7-10 Year Treasury Bond (IEF) when Republicans hold it.

We use calendar years to determine party holding the presidency. As benchmarks, we consider buying and holding each of SPY, IWM, LQD or IEF and annually rebalanced portfolios of 60% SPY and 40% LQD (60 SPY-40 LQD) or 60% SPY and 40% IEF (60 SPY-40 IEF). We consider as performance metrics: average annual excess return (relative to the yield on 1-year U.S. Treasury notes at the beginning of each year); standard deviation of annual excess returns; annual Sharpe ratio; compound annual growth rate (CAGR); and, maximum annual drawdown (annual MaxDD). We assume portfolio switching/rebalancing frictions are negligible. Except for CAGR, computations are for full calendar years only. Using monthly dividend-adjusted closing prices for the specified ETFs during July 2002 (limited by LQD and IEF) through December 2022, we find that:

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A subscriber asked about the performance of a strategy that each month allocates funds to pairs of exchange-traded fund (ETF) asset class proxies according to the term spread, as measured by the difference in yields between the 10-Year constant maturity U.S. Treasury note and the 3-Month U.S. Treasury bill (T-bill). Specifically:

• When the term spread is less than 0%, hold 50% Invesco DB Commodity Index Tracking Fund (DBC) and 50% SPDR Gold Shares (GLD), rebalanced monthly.
• When the term spread is 0% to 2%, hold 50% SPDR S&P 500 ETF Trust (SPY) and 50% iShares MSCI EAFE (EFA), rebalanced monthly.
• When the term spread is greater than 2%, hold 50% iShares 20+ Year Treasury Bond (TLT) and 50% Vanguard Real Estate Index Fund (VNQ), rebalanced monthly.

Also, how does the performance of this strategy (Term Spread Strategy) compare to that of a portfolio that each month allocates 50% to Simple Asset Class ETF Value Strategy (SACEVS) Best Value and 50% to Simple Asset Class ETF Momentum Strategy (SACEMS) equal-weighted (EW) Top 2. We begin the test at the end of June 2006, limited by SACEMS inputs. We ignore monthly rebalancing frictions for both strategies. Using monthly dividend-adjusted prices for the specified ETFs starting June 2006 and monthly gross returns for 50-50 SACEVS Best Value and SACEMS EW Top 2 starting July 2006, all through November 2022, we find that: Keep Reading

Do Federal Funds Rate (FFR) actions taken by the Federal Reserve open market operations committee reliably predict stock market and U.S. Treasuries yield reactions? To investigate, we use the S&P 500 Index as a proxy for the stock market and the yield for the 10-Year U.S. Constant Maturity Treasury note (T-note). We look at index returns and changes in T-note yield during the one and two months after FFR actions, separately for FFR increases and FFR decreases. Using data for the three series during January 1990 through mid-December 2022, we find that:

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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, and SPY and TLT total returns during mid-December 2002 through late October 2022, we find that: Keep Reading

Noting that iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and iShares 20+ Year Treasury Bond ETF (TLT) exhibit a moderately positive return correlation, a subscriber asked about substituting Vanguard High-Yield Corporate Fund Investor Shares (VWEHX) for LQD in the Simple Asset Class ETF Value Strategy (SACEVS) to exploit undervaluation of the credit risk premium. 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.

To investigate, we compare performances of SACEVS Best Value and SACEVS Weighted portfolios with either VWEHX or LQD as the credit risk asset. Using monthly total returns for SACEVS assets during July 2002 through September 2022, we find that:

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