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Value Investing Strategy (Strategy Overview)

Allocations for August 2022 (Final)

Momentum Investing Strategy (Strategy Overview)

Allocations for August 2022 (Final)
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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.

When Gold Wins?

Why have inflation, economic uncertainty and geopolitical uncertainty not driven up the price of gold? In their brief May 2022 commentary entitled “Why Isn’t the Gold Price Higher?”, Paul Gambles and James Fraser review the times when gold is, and is not, a good investment. Based on historical gold prices, with focus on recent decades, they conclude that: Keep Reading

Asset Class and Factor Premium Performances Across Inflation Regimes

How should investors reposition portfolios across inflationary regimes (deflation, low inflation, mild inflation, high inflation)? In their July 2022, paper entitled “Investing in Deflation, Inflation, and Stagflation Regimes”, Guido Baltussen, Laurens Swinkels and Pim van Vliet examine asset class and factor returns across inflationary regimes. They first construct long monthly return histories for asset classes (global equities, bonds and cash) and four factors (value, momentum, low-risk and quality/carry) as applied to equities, bonds and a multi-asset portfolio. They then segment the long sample into four global inflation regimes: (1) below 0% (deflation); (2) 0% to 2% (low); (3) 2% to 4% (mild); and, (4) above 4% (high). They next define sub-regimes (most notably for high inflation) according to other economic variables, with focus on stagflation (high inflation and economic downturn as measured by recessions, weakening earnings or falling equity markets). They further divide sub-regimes based on increasing/decreasing long-term interest rates or inflation rates. Using monthly inflation and asset price data as specified during 1875 through 2021 (147 years), they find that:

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Inflation Forecast Update

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

Expert Estimates of 2022 Country Equity Risk Premiums and Risk-free Rates

What are current estimates of equity risk premiums (ERP) and risk-free rates around the world? In their May 2022 paper entitled “Survey: Market Risk Premium and Risk-Free Rate Used for 95 Countries in 2022”, Pablo Fernandez, Teresa García de Santos and Javier Acin summarize results of a May 2022 email survey of international economic professors, analysts and company managers “about the Risk-Free Rate and the Market Risk Premium (MRP) used ‘to calculate the required return to equity in different countries.'” Results are in local currencies. Based on 4,337 specific and credible premium estimates spanning 95 countries for which there are at least six estimates, they find that: Keep Reading

Debt-to-GDP Ratio and Investment Risk Premiums

Is the government debt-to-Gross Domestic Product (GDP) ratio a useful predictor of stock and bond market returns? In his May 2021 paper entitled “Government Debt and Risk Premia”, Yang Liu examines relationships between future stock and bond market excess returns (relative to short term government bills) and government debt-to-GDP ratio. He measures government debt as market value of the federal government debt held by the public. For the U.S., this means aggregate market value of all Treasury bonds, Treasury notes, Treasury bills, TIPS, etc. across maturities, excluding government accounts and Federal Reserve holdings. Using debt and GDP data for the U.S. during 1926 through the mid-2010s, associated U.S. stock and bond market return data during 1926 through 2020 and comparable data for 19 major developed countries spanning 1970 through 2018, he finds that:

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CPI-to-PPI Ratio and the Stock Market

In response to “PPI and the Stock Market”, a subscriber hypothesized that increases and decreases in the ratio of the Consumer Price Index (CPI) to the Producer Price Index (PPI) are bullish and bearish for the stock market, respectively. The reasoning for the hypothesis is that CPI reflects aggregate corporate revenue, while PPI reflects aggregate costs. The ratio CPI/PPI therefore relates to aggregate profitability, which should translate to stock market level. To test this hypothesis, we construct U.S. CPI/PPI monthly from non-seasonally adjusted CPI and non-seasonally adjusted PPI. We then relate changes in this ratio to S&P 500 Index returns. Using CPI and PPI values and S&P 500 Index levels during December 1927 through April 2022, we find that: Keep Reading

PPI and the Stock Market

Inflation at the producer level (per the Producer Price Index, PPI) is arguably an advance indicator for inflation downstream at the consumer level (per the Consumer Price Index, CPI). Do investors reliably react to changes in PPI as an indicator of the future wealth discount rate? In other words, is a high (low) producer-level inflation rate bad (good) for the stock market? Using monthly, non-seasonally adjusted PPI from the Bureau of Labor Statistics (BLS) and S&P 500 Index levels during December 1927 through April 2022, we find that: Keep Reading

Gold Return vs. Change in M2

A subscriber requested confirmation of the following relationship between U.S. M2 Money Stock and gold offered in “Why Gold May Be Looking Cheap”: “[O]ne measure I’ve found useful is the ratio of the price of gold to the U.S. money supply, measured by M2, which includes cash as well as things like money market funds, savings deposits and the like. The logic is that over the long term the price of gold should move with the change in the supply of money… That equilibrium level is also relevant for future price action. When the ratio is low, defined as 25% below equilibrium, the medium 12-month return has been over 12%. Conversely, when the ratio is high, defined as 25% above equilibrium, the 12-month median return has been -6%. …This measure can be refined further. [G]old tends to trade at a higher ratio to M2 when inflation is elevated.” Because it retrospectively defines specific valuation thresholds using the full sample, this approach impounds lookahead bias/data snooping bias in threshold selection. We consider an alternative setup that relates monthly change in M2 to monthly gold return. We also consider the effect of inflation on this relationship. Using monthly seasonally adjusted M2 and end-of-month London PM gold price fix during January 1976 (to ensure a free U.S. gold market) through March 2022, we find that: Keep Reading

EFFR and the Stock Market

Do changes in the Effective Federal Funds Rate (EFFR), the actual cost of short-term liquidity derived from a combination of market demand and Federal Reserve open market operations designed to maintain the Federal Funds Rate (FFR) target, predictably influence the U.S. stock market over the horizons up to a few months? To investigate, we relate smoothed (volume-weighted median) monthly levels of EFFR to monthly U.S. stock market returns (S&P 500 Index or Russell 2000 Index) over available sample periods. Using monthly data as specified since July 1954 for EFFR and the S&P 500 Index (limited by EFFR) and since September 1987 for the Russell 2000 Index, all through March 2022, we find that: Keep Reading

Time EEM with Real T-note Yield?

A subscriber, citing an assertion (without explanation) from an interview with a hedge fund manager, asked for confirmation that negative real yields on U.S. Treasury instruments predict poor returns for emerging market equities.  To investigate, we look at interactions between the real return on 10-year U.S. Treasury notes (T-notes) and return on iShares MSCI Emerging Markets ETF (EEM). We calculate the real yield on T-notes by substracting from its nominal yield the inflation rate for the last 12 months as indicated by the U.S. Consumer Price Index, All Items (CPI). We measure T-note yield and dividend-adjusted EEM price at the close on monthly CPI release dates. Using the specified monthly data during April 2003 (limited by EEM history) through March 2022, we find that: Keep Reading

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