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Value Investing Strategy (Strategy Overview)

Allocations for September 2021 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for September 2021 (Final)
1st ETF 2nd ETF 3rd ETF

Economic Indicators

The U.S. economy is a very complex system, with indicators therefore ambiguous and difficult to interpret. To what degree do macroeconomics and the stock market go hand-in-hand, if at all? Do investors/traders: (1) react to economic readings; (2) anticipate them; or, (3) just muddle along, mostly fooled by randomness? These blog entries address relationships between economic indicators and the stock market.

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 August 2021, we find that: Keep Reading

Inflation Forecast Update

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for August 2021. The actual total (core) inflation rate is slightly higher than (a little lower than) forecasted.

Comparing the Sahm Indicator and the Yield Curve

In response to “Combining SMA10 and Sahm Indicator”, a subscriber asked for a comparison of signals generated by the Sahm Recession Indicator (Sahm) and by yield curve inversion. The former signals a recession when the 3-month simple moving average (SMA) of the U.S. unemployment rate is at least 0.5% higher than its low during the last 12 months. The latter signals a recession when the yield on the 3-month U.S. Treasury bill (T-bill) rises above the yield on the 10-year U.S. Treasury note (T-note). To investigate, we calculate average monthly returns and standard deviations of monthly returns for the S&P 500 Index (SP500):

  • When Sahm does not indicate a recession and, separately, when it does.
  • When the yield curve does not indicate a recession and, separately, when it does.
  • When SP500 is below its 10-month SMA (SMA10) and, separately, when it is above (for additional perspective).

Using end-of-month levels of SP500 since March 1959, Sahm levels since inception in December 1959 (history vintage 8/6/2021) and T-bill and T-note yields since December 1959, all through July 2021, we find that:

Keep Reading

Should the “Anxious Index” Make Investors Anxious?

Since 1990, the Federal Reserve Bank of Philadelphia has conducted a quarterly Survey of Professional Forecasters. The American Statistical Association and the National Bureau of Economic Research conducted the survey from 1968-1989. Among other things, the survey solicits from experts probabilities of U.S. economic recession (negative GDP growth) during each of the next four quarters. The survey report release schedule is mid-quarter. For example, the release date of the third quarter 2021 report is August 13, 2021, with forecasts through the third quarter of 2022. The “Anxious Index” is the probability of recession during the next quarter. Are these forecasts meaningful for future U.S. stock market returns? Rather than relate the probability of recession to stock market returns, we instead relate one minus the probability of recession (the probability of good times). If forecasts are accurate, a relatively high (low) forecasted probability of good times should indicate a relatively strong (weak) stock market. Using survey results and quarterly S&P 500 Index levels (on survey release dates as available, and mid-quarter before availability of release dates) from the fourth quarter of 1968 through the third quarter of 2021 (212 surveys), we find that:

Keep Reading

Combining SMA10 and Sahm Indicator

A subscriber asked about a stock market timing strategy that combines the market 10-month simple moving average (SMA10) and the Sahm Recession Indicator (Sahm), which signals the start of a recession when the 3-month SMA of the U.S. unemployment rate is at least 0.5% higher than its low during the last 12 months. Specifically, the strategy:

  • Holds the S&P 500 Index (SP500) unless it is below its SMA10 and Sahm first signals a recession.
  • Subsequently holds cash until SP500 crosses above its SMA10.

To investigate, we compare three alternative strategies:

  1. SP500 – buy and hold the index.
  2. SMA10 – hold the index only while it is above its SMA10 and otherwise hold cash.
  3. SMA10+Sahm – combined signals as specified above.

We focus on average monthly return, standard deviation of monthly returns, monthly reward/risk (average return divided by standard deviation), compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics. Using end-of-month levels of SP500 since March 1959, Shiller’s monthly SP500 dividends (to estimate SP500 total returns) since January 1960, Sahm since inception in December 1959 (history vintage 8/6/2021) and T-bill yield since December 1959, all through July 2021, we find that:

Keep Reading

Misery Index and Future U.S. Stock Market Returns

Does the Misery Index, the sum of the U.S. total inflation rate and the U.S. unemployment rate, predict U.S. stock market returns? To investigate, we relate monthly Misery Index and monthly change in Misery Index to monthly S&P 500 Index (SP500) returns. Using monthly Misery Index level and monthly SP500 level during January 1948 (limited by the Misery Index) through June 2021, we find that: Keep Reading

U.S. Stock Market Returns Around Scheduled FOMC Meetings

A subscriber requested testing of a strategy that buys SPDR S&P 500 (SPY) at the open on the day before each scheduled Federal Open Market Committee (FOMC) meeting and sells at the close. Using daily dividend-adjusted SPY open and close prices and dates of FOMC meetings during January 2016 through June 2021 (43 meetings), we find that: Keep Reading

Unemployment Rate and Stock Market Returns

Financial media and expert commentators often cite the U.S. unemployment rate as an indicator of economic and stock market health, generally interpreting a jump (drop) in the unemployment rate as bad (good) for stocks. Conversely, investors may interpret a falling unemployment rate as a trigger for increases in the Federal Reserve target interest rate (and adverse stock market reactions). Is this variable in fact predictive of U.S. stock market behavior in subsequent months, quarters and years? Using monthly seasonally adjusted unemployment rate from the U.S. Bureau of Labor Statistics (BLS) and monthly S&P 500 Index levels during January 1948 (limited by unemployment rate data) through June 2021, we find that: Keep Reading

Employment and Stock Market Returns

U.S. job gains or losses receive prominent coverage in the monthly financial news cycle, with media and expert commentators generally interpreting employment changes as an indicator of future economic and stock market health. One line of reasoning is that jobs generate personal income, which spurs personal consumption, which boosts corporate earnings and lifts the stock market. Are employment changes in fact predictive of U.S. stock market behavior in subsequent months, quarters and years? Using monthly seasonally adjusted non-farm employment data from the U.S. Bureau of Labor Statistics (BLS) and monthly S&P 500 Index levels during January 1939 (limited by employment data) through June 2021, we find that: Keep Reading

Credit Spread as an Asset Return Predictor

A reader commented and asked: “A wide credit spread (the difference in yields between Treasury notes or Treasury bonds and investment grade or junk corporate bonds) indicates fear of bankruptcies or other bad events. A narrow credit spread indicates high expectations for the economy and corporate world. Does the credit spread anticipate stock market behavior?” To investigate, we define the U.S. credit spread as the difference in yields between Moody’s seasoned Baa corporate bonds and 10-year Treasury notes (T-note), which are average daily yields for these instruments by calendar month (a smoothed measurement). We use the S&P 500 Index (SP500) as a proxy for the U.S. stock market. We extend the investigation to bond market behavior via:

Using monthly Baa bond yields, T-note yields and SP500 closes starting April 1953 and monthly dividend-adjusted closes of VUSTX, VWESX and VWEHX starting May 1986, January 1980 and January 1980, respectively, all through June 2021, we find that: Keep Reading

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