Bonds

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, EFFR, total 12-month U.S. inflation and core 12-month U.S. inflation during March 1989 (limited by availability of operating earnings data) through September 2023, we find that: Keep Reading

What conditions affect the correlation between stock and bond returns, a critical input to asset allocation decisions? In their July 2023 paper entitled “Empirical Evidence on the Stock-Bond Correlation”, Roderick Molenaar, Edouard Senechal, Laurens Swinkels and Zhenping Wang relate changes in this correlation to economic variables and analyze the implications of such changes for stock-bond portfolios. They employ rolling 36-month Spearman rank correlations for stock market and 10-year government bond returns to detect correlation changes. While considering longer periods, they focus on post-1952 monthly and post-1978 daily U.S. data (after Federal Reserve independence) as most representative of the future. Using stock and bond returns and economic data starting 1875 for the U.S., 1801 for the UK, 1871 in France and 1987 for Canada, Germany, Italy and Japan, all through 2021, they find that:

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How do returns of different asset classes recently interact with inflation as measured by monthly change in the not seasonally adjusted, all-items consumer price index (CPI) from the U.S. Bureau of Labor Statistics? To investigate, we look at lead-lag relationships between change in CPI 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 total CPI values and monthly dividend-adjusted prices for the 10 specified ETFs during December 2007 (limited by EMB) through June 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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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

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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Is the gap between the yield on the 10-year constant maturity U.S. Treasury note (T-note) and the 10-Year breakeven inflation rate (a measure of expected inflation over the next 10 years derived from T-note yield and 10-Year Treasury inflation-indexed constant maturity securities yield) indicative of future stock market or U.S. Treasury bond yields? To investigate, we relate monthly values of this gap (the expected real T-note gap) and changes in the gap to future monthly returns for SPDR S&P 500 ETF Trust (SPY) and iShares 20+ Year Treasury Bond ETF (TLT). Using monthly values for the four series during January 2003, limited by the breakeven inflation rate series, through July 2022, we find that: Keep Reading

A subscriber asked whether there are any lead-lag relationships between gold, proxied by SPDR Gold Shares (GLD), and 10-year U.S. Treasury note (T-note) yields. As a proxy for the latter, we use iShares 7-10 Year Treasury Bond ETF (IEF). Using daily and monthly dividend-adjusted prices for GLD and IEF during mid-November 2004 (limited by GLD) through late July 2022, we find that: Keep Reading