Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for September 2020 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for September 2020 (Final)
1st ETF 2nd ETF 3rd ETF

Equity Premium

Governments are largely insulated from market forces. Companies are not. Investments in stocks therefore carry substantial risk in comparison with holdings of government bonds, notes or bills. The marketplace presumably rewards risk with extra return. How much of a return premium should investors in equities expect? These blog entries examine the equity risk premium as a return benchmark for equity investors.

Stocks for the Long Run Internationally

Are buy-and-hold stock market returns attractive over the long run globally? In their May 2020 paper entitled “Stocks for the Long Run? Evidence from a Broad Sample of Developed Markets”, Aizhan Anarkulova, Scott Cederburg and Michael O’Doherty apply a stationary block bootstrap procedure (retaining some time series features) to generate distributions of 1,000,000 each 1-month to 30-year real returns across global equity markets. They mitigate survivorship and easy data biases via broad coverage of developed countries and inclusion of market interruptions. They focus on a long-term (30-year) investment horizon, with returns accumulated in local currencies. Using monthly total (dividend-reinvested) equity index returns and consumer price indexes for 39 developed countries as available according to certain criteria during January 1841 through December 2019, they find that: Keep Reading

Behaviors and Characteristics of Top Stocks

What are typical return behaviors and firm characteristics of the best-performing and worst-performing U.S. stocks at a 10-year horizon? In his July 2020 series of papers entitled “Extreme Stock Market Performers”, Part I: Expect Some Drawdowns, Part II: Do Technology Stocks Dominate?, Part III: What are their Observable Characteristics? and Part IV: Can Observable Characteristics Forecast Outcomes?, Hendrik Bessembinder investigates returns and firm characteristics of stocks that generate the most and least total shareholder wealth (are the “best” and “worst” stocks) in each decade since 1950. Total shareholder wealth generation incorporates both cumulative return and market capitalization. Using monthly returns, market capitalizations and firm characteristics for U.S. stocks for each decade during 1950 through 2019, he finds that: Keep Reading

Evaluating Country Investment Risk

How should global investors assess country sovereign bond and equity risks? In his July 2020 paper entitled “Country Risk: Determinants, Measures and Implications – The 2020 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

Are Equity Multifactor ETFs Working?

Are equity multifactor strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider seven ETFs, all currently available:

  • iShares Edge MSCI Multifactor USA (LRGF) – holds large and mid-cap U.S. stocks with focus on quality, value, size and momentum, while maintaining a level of risk similar to that of the market.
  • iShares Edge MSCI Multifactor International (INTF) – holds global developed market ex U.S. large and mid-cap stocks based on quality, value, size and momentum, while maintaining a level of risk similar to that of the market.
  • Goldman Sachs ActiveBeta U.S. Large Cap Equity (GSLC) – holds large U.S. stocks based on good value, strong momentum, high quality and low volatility.
  • John Hancock Multifactor Large Cap (JHML) – holds large U.S. stocks based on smaller capitalization, lower relative price and higher profitability, which academic research links to higher expected returns.
  • John Hancock Multifactor Mid Cap (JHMM) – holds mid-cap U.S. stocks based on smaller capitalization, lower relative price and higher profitability, which academic research links to higher expected returns.
  • JPMorgan Diversified Return U.S. Equity (JPUS) – holds U.S. stocks based on value, quality and momentum via a risk-weighting process that lowers exposure to historically volatile sectors and stocks.
  • Xtrackers Russell 1000 Comprehensive Factor (DEUS) – seeks to track, before fees and expenses, the Russell 1000 Comprehensive Factor Index, which seeks exposure to quality, value, momentum, low volatility and size factors.

We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). We use four benchmarks according to fund descriptions: SPDR S&P 500 (SPY), iShares MSCI ACWI ex US (ACWX), SPDR S&P MidCap 400 (MDY) and iShares Russell 1000 (IWB). Using monthly returns for the seven equity multifactor ETFs and benchmarks as available through August 2020, we find that: Keep Reading

Party in Power and Stock Returns

Past research relating U.S. stock market returns to the party holding the Presidency mostly concludes that Democratic presidents are better for the stock market than Republican presidents. However, Presidents share power conferred by the electorate with Congress. Does historical data confirm that Democratic control of Congress is also better for stock market returns than Republican control of Congress? Is control of the smaller Senate more decisive than control of the House of Representatives? To check, we relate annual U.S. stock market (S&P 500 Index) returns to various combinations of party control of the Presidency, the Senate and the House of Representatives. Using party in power data and annual levels of the S&P 500 Index for December 1927 through December 2019 (92 years), we find that: Keep Reading

Best Stock Return Anomaly Double Sorts?

Are portfolios of U.S. stocks that are double-sorted to capture benefits of two complementary return anomalies attractive? In their July 2020 paper entitled “Interacting Anomalies”, Karsten Müller and Simon Schmickler test all possible double-sorted portfolios across 102 stock return anomalies (10,302 double-sorts). They employ 5×5 double-sorts, first ranking stocks into fifths (quintiles) for one anomaly and then re-sorting each of these quintiles into fifths for the second anomaly. They focus on the four “corner” portfolios involving the extreme high and low quintiles for both anomalies. They evaluate average returns, Sharpe ratios and factor model alphas of both equal-weighted (EW) and value-weighted (VW) versions of these portfolios, emphasizing performance gains from anomaly interactions. They correct for multiple hypothesis testing (data snooping bias) using the Bonferroni correction. Using trading and accounting data for a broad sample of U.S. common stocks with annual (quarterly) accounting data lagged by six (four) months during 1970 through 2017, they find that:

Keep Reading

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 July 2020, we find that: Keep Reading

Are ESG ETFs Attractive?

Do exchange-traded funds selecting stocks based on environmental, social, and governance characteristics (ESG ETF) typically offer attractive performance? To investigate, we compare performance statistics of seven ESG ETFs, all currently available, to those of simple and liquid benchmark ETFs, as follows:

  1. iShares MSCI USA ESG Select ETF (SUSA), with SPDR S&P 500 ETF Trust (SPY) as a benchmark.
  2. iShares MSCI KLD 400 Social ETF (DSI), with SPY as a benchmark.
  3. iShares ESG MSCI EM ETF (ESGE), with iShares MSCI Emerging Markets ETF (EEM) as a benchmark.
  4. iShares ESG MSCI USA ETF (ESGU), with SPY as a benchmark.
  5. Nuveen ESG Small-Cap ETF (NUSC), with iShares Russell 2000 ETF (IWM) as a benchmark.
  6. Vanguard ESG U.S. Stock ETF (ESGV), with SPY as a benchmark.
  7. Vanguard ESG International Stock ETF (VSGX), with Vanguard FTSE All-World ex-US Index Fund ETF (VEU) as a benchmark.

We focus on average return, standard deviation of returns, compound annual growth rate (CAGR) and maximum drawdown (MaxDD), all based on monthly data. Using monthly dividend-adjusted returns for all specified ETFs since inceptions and for all benchmarks over matched sample periods through June 2020, we find that: Keep Reading

Testing a Countercyclical Asset Allocation Strategy

“Countercyclical Asset Allocation Strategy” summarizes research on a simple countercyclical asset allocation strategy that systematically raises (lowers) the allocation to an asset class when its current aggregate allocation is relatively low (high). The underlying research is not specific on calculating portfolio allocations and returns. To corroborate findings, we use annual mutual fund and exchange-traded fund (ETF) allocations to stocks and bonds worldwide from the 2020 Investment Company Fact Book, Data Tables 3 and 11 to determine annual countercyclical allocations for stocks and bonds (ignoring allocations to money market funds). Specifically:

  • If actual aggregate mutual fund/ETF allocation to stocks in a given year is above (below) 60%, we set next-year portfolio allocation below (above) 60% by the same percentage.
  • If actual aggregate mutual fund/ETF allocation to bonds in a given year is above (below) 40%, we set next-year portfolio allocation below (above) 40% by the same percentage.

We then apply next-year allocations to stock (Fidelity Fund, FFIDX) and bond (Fidelity Investment Grade Bond Fund, FBNDX) mutual funds that have long histories. Based on Fact Book annual publication dates, we rebalance at the end of April each year. Using the specified actual fund allocations for 1984 through 2019 and FFIDX and FBNDX May through April total returns and April 1-year U.S. Treasury note (T-note) yields for 1985 through 2020, 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, SPY and TLT during mid-December 2002 through early July 2020, we find that: Keep Reading

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