Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for February 2023 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for February 2023 (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.

Recent Interactions of Asset Classes with Effective Federal Funds Rate

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

Inflation Forecast Update

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for December 2022. The actual total (core) inflation rate is lower than (slightly higher than) forecasted.

FFR Actions, Stock Market Returns and Bond Yields

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:

Keep Reading

Retail Sales Growth and Stock Market Returns

Do monthly retail sales data reliably predict U.S. stock market behavior? To investigate, we relate monthly change in retail sales to monthly S&P 500 Index return. We consider both seasonally adjusted (SA) and non-seasonally adjusted (NSA) retail sales series, as compiled by the the U.S. Census Bureau. Using monthly levels of retail sales and the S&P 500 Index during January 1992 (limited by retail sales data) through October 2022, we find that: Keep Reading

Stocks-Bonds Return Correlation and Inflation

A subscriber asked whether the correlation between returns on stocks and bonds is elevated when inflation is above 5%, such that equities and fixed income offer little diversification protection. To investigate, we calculate the U.S. overall inflation rate from monthly values of the consumer price index over the prior year to find months with the inflation rate over 5%. We then compute monthly total return correlations for the following two pairs of funds when inflation is above or not above 5%:

  1. Fidelity Fund (FFIDX) and Fidelity Investment Grade Bond Fund (FBNDX).
  2. SPDR S&P 500 ETF Trust (SPY) and iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).

Using monthly dividend-adjusted prices for FFIDX and FBNDX since January 1980 and for SPY and LQD since July 2002, all through September 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

Asset Class Reactions to Monthly Inflation Data

How do individual asset classes react to monthly inflation indications? To investigate, we relate future monthly returns for the following asset class exchange-traded fund (ETF) proxies to monthly changes in the U.S. Consumer Price Index (CPI):

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

Using monthly CPI data (all items) and monthly dividend-adjusted returns for the above 10 asset class proxy ETFs as available from July 2002 through September 2022, we find that: Keep Reading

Equity Factors Come and Go with Economic Regimes?

Are many accepted equity factors/return anomalies artifacts of the secular decline in interest rates during their discovery sample periods? In their September 2022 paper entitled “The Factor Multiverse: The Role of Interest Rates in Factor Discovery”, Jules van Binsbergen, Liang Ma and Michael Schwert study the role of the secular decline in interest rates since the early 1980s in the discovery of equity factors/return anomalies. They use value-weighted long-short portfolios and monthly reformation for all factors/anomalies. They apply duration-matched fixed income portfolio return adjustments to returns for each anomaly portfolio to model returns for the latter if there had been no interest rate decline. They then classify each anomaly as false positive (present for unadjusted returns, but not adjusted returns), false negative (present for adjusted returns, but not unadjusted returns) or robust to the effect of interest rates (present for both unadjusted and adjusted returns). Using monthly returns for 153 accepted factors/anomalies over respective original test periods and for 1,395 potential undiscovered factors/anomalies based on firm accounting variables during July 1962 through December 2020, along with contemporaneous yield data for zero coupon U.S. Treasury bonds and notes, they 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 2022 report is August 12, 2022, with forecasts through the third quarter of 2023. 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 2022 (216 surveys), we find that:

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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 2022, we find that: Keep Reading

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