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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.

U.S. Equity Premium?

A subscriber requested measurement of a “premium” associated with U.S. stocks relative to those of other developed markets by looking at the difference in returns between the following two exchange-traded funds (ETF):

Using monthly dividend-adjusted closing prices for these ETFs during August 2001 (limited by EFA) through January 2022, we find that: Keep Reading

Tech Equity Premium?

A subscriber requested measurement of a “premium” associated with stocks of innovative technology firms by looking at the difference in returns between the following two exchange-traded funds (ETF):

Using monthly dividend-adjusted closing prices for these ETFs during March 1999 (limited by QQQ) through January 2022, we find that: Keep Reading

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 specified ETFs during December 2007 (limited by EMB) through December 2021, we find that: Keep Reading

Variation in the Number of Significant Equity Factors

Does the number of factors significantly predicting next-month stock returns vary substantially over time? If so, what accounts for the variation? In their December 2021 paper entitled “Time Series Variation in the Factor Zoo”, Hendrik Bessembinder, Aaron Burt and Christopher Hrdlicka investigate time variation in the statistical significance of 205 previously identified equity factors before, during and after the sample periods used for their discoveries. Specifically, they track 1-factor (market) alphas of each factor over rolling 60-month intervals over a long sample period. Their criterion for significance for each factor in each interval is a t-statistic of at least 1.96 (95% confidence that alpha is positive). Using monthly returns for all common stocks listed on NYSE, AMEX and NASDAQ exchanges having at least 60 continuous months of data as available during July 1926 (with alpha series therefore starting June 1931) through December 2020, they find that: Keep Reading

Finding the Efficient Passive ETFs

Are some passive exchange-trade-fund (ETF) managers more efficient than others in adjusting to changes in underlying benchmark indexes? In the December 2021 revision of his paper entitled “Should Passive Investors Actively Manage Their Trades?”, Sida Li employs daily holding data of passive ETFs to compare and quantify effects of different approaches to portfolio reformation to track underlying indexes. Using daily and monthly holdings as available for 732 passive and unlevered U.S. equity ETFs (with no survivorship bias), underlying index reformation announcements and associated stock prices during 2012 through 2020, he finds that:

Keep Reading

Recent Interactions of Asset Classes with Economic Policy Uncertainty

How do returns of different asset classes recently interact with uncertainty in government economic policy as quantified by the Economic Policy Uncertainty (EPU) Index? This index at the beginning of each month incorporates from the prior month:

  1. Coverage of policy-related economic uncertainty by prominent newspapers (50% weight).
  2. Number of temporary federal tax code provisions set to expire in future years (one sixth weight).
  3. Level of disagreement in one-year forecasts among participants in the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters for both (a) the consumer price index (one sixth weight) and (b) purchasing of goods and services by federal, state and local governments (one sixth weight).

Because the historical EPU Index series includes substantial revisions to prior months, we focus on monthly percentage changes in EPU Index and look at lead-lag relationships between change in EPU Index 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 levels of the EPU Index and monthly dividend-adjusted prices for the 10 specified ETFs during December 2007 (limited by EMB) through December 2021, we find that: Keep Reading

Recent Interactions of Asset Classes with Inflation (PPI)

How do returns of different asset classes recently interact with inflation as measured by monthly change in the not seasonally adjusted, all-commodities producer price index (PPI) from the U.S. Bureau of Labor Statistics? To investigate, we look at lead-lag relationships between change in PPI 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 PPI values and monthly dividend-adjusted prices for the 10 specified ETFs during December 2007 (limited by EMB) through December 2021, we find that: Keep Reading

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 December 2021, 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 2021 (94 years), we find that: Keep Reading

Labor Force Participation Rate and Stock Market Returns

Does the labor force participation rate, measured monthly by the U.S. Bureau of Labor Statistics along with employment and unemployment rate, predict U.S. stock market returns? An increasing (decreasing) participation rate may may indicate strong (weak) employment demand and therefore a strong (weak) economy. To investigate, we relate participation rate to performance of the S&P 500 Index as a proxy for the stock market. Using monthly participation rate and index level during January 1948 (limited by the former) through December 2021, we find that: Keep Reading

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