Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for July 2024 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for July 2024 (Final)
1st ETF 2nd ETF 3rd ETF

Bonds

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.

Recent Interactions of Asset Classes with Inflation (CPI)

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

Evaluating Country Investment Risk

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

TIP as Return Predictor Across Asset Classes

“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

Fed Model Nuance

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:

Keep Reading

Testing a Term Premium Asset Allocation Strategy

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:

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

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

More Aggressive Pursuit of the Credit Premium in SACEVS?

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:

Keep Reading

Expected Real T-note Gap and Future Asset Returns

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

Any Lead-lag Relationships Between Gold and 10-year U.S. Treasuries?

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

High-yield Bond Spread and Stock Market Returns

A subscriber asked about the relationship between the high-yield bond spread and stock market return, with focus on when the latter is entering a bear market. To investigate, we use the ICE BofA US High Yield Index Option-Adjusted Spread (HY Spread) as a proxy for the high-yield bond spread and SPDR S&P 500 ETF Trust (SPY) as a proxy for the U.S. stock market. We look at the following interactions between HY Spread and SPY:

  • Daily lead-lag correlations between HY Spread/change in HY Spread and SPY return.
  • Monthly lead-lag correlations between HY Spread/change in HY Spread and SPY return.
  • Average next-month SPY return by range of monthly changes in HY Spread.
  • Monthly changes in HY Spread before the worst next-month SPY returns.
  • Next-month SPY returns after the biggest monthly jumps in HY Spread.

Using daily values of HY Spread and daily dividend-adjust SPY prices from the end of December 1996 (limited by HY Spread) through mid-June 2022, we find that: Keep Reading

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