Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for September 2022 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for September 2022 (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.

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

Substitute VIG for SPY in SACEVS and SACEMS?

A subscriber asked whether substituting the less volatile Vanguard Dividend Appreciation Index Fund (VIG) for SPDR S&P 500 (SPY) in the Simple Asset Class ETF Value Strategy (SACEVS) and the Simple Asset Class ETF Momentum Strategy (SACEMS) would improve outcomes. To investigate, we substitute monthly VIG dividend-adjusted returns for SPY dividend-adjusted returns in the two model strategies. Because VIG is not available for the entire sample periods used in the tracked models, we splice VIG returns into the SPY position starting with inception of the former in May 2006. We then compare the spliced performance with the original baseline performance, including: gross compound annual growth rates (CAGR), gross annual returns, average gross annual returns, standard deviations of gross annual returns, gross annual Sharpe ratios and maximum drawdowns (MaxDD). In Sharpe ratio calculations, we employ the average monthly yield on 3-month U.S. Treasury bills during a year as the risk-free rate for that year. Using the specified methodology and data to generate SACEVS monthly returns starting August 2002 and SACEMS monthly returns starting July 2006, all through December 2021, we find that:

Keep Reading

Simple Sector ETF Momentum Strategy Update/Extension

“Simple Sector ETF Momentum Strategy” investigates performances of simple momentum trading strategies for the following nine sector exchange-traded funds (ETF) executed with Standard & Poor’s Depository Receipts (SPDR):

Materials Select Sector SPDR (XLB)
Energy Select Sector SPDR (XLE)
Financial Select Sector SPDR (XLF)
Industrial Select Sector SPDR (XLI)
Technology Select Sector SPDR (XLK)
Consumer Staples Select Sector SPDR (XLP)
Utilities Select Sector SPDR (XLU)
Health Care Select Sector SPDR (XLV)
Consumer Discretionary Select SPDR (XLY)

Here, we update the principal strategy and extend it by adding equally weighted combinations of the top two and top three sector ETFs, along with corresponding robustness tests and benchmarks. We present findings in formats similar to those used for the Simple Asset Class ETF Momentum Strategy and the Simple Asset Class ETF Value Strategy. Using monthly dividend-adjusted closing prices for the sector ETFs and SPDR S&P 500 (SPY), 3-month U.S. Treasury bill (T-bill) yield and S&P 500 Index level during December 1998 through December 2021, we find that: Keep Reading

TLT-SPY Return Delta as Stock Market Crash Indicator

A subscriber hypothesized that a very large delta between daily iShares 20+ Year Treasury Bond (TLT) and SPDR S&P 500 (SPY) returns presages a stock market collapse, and asked for verification. To investigate, we consider two tests:

  1. Calculate correlations between daily TLT-SPY return delta and daily SPY returns over the next month (21 trading days). A stock market collapse during this interval should exhibit very negative correlations.
  2. Compute average next-day SPY returns by ranked tenth (decile) of daily TLT-SPY return deltas. Average SPY returns should be relatively very low for high deciles.

Using daily dividend-adjusted prices for TLT and SPY during late July 2002 (limited by TLT) through mid-December 2021, we find that: Keep Reading

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 late December 2021, we find that:

Keep Reading

Defensive-in-May Sector Rotation

A subscriber asked about a strategy that holds a portfolio of cyclical sectors and small capitalization stocks during November through April and a portfolio of defensive sectors during May through October, as follows:

We use NAESX for small stocks to obtain a history as long as those for the equity sectors. We weight components of the cyclical and defensive portfolios equally. We use buy-and-hold NAESX and an equal-weighted, semiannually rebalanced portfolio of all seven funds (Sector EW) as benchmarks. We focus on semiannual return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using semiannual dividend-adjusted prices for the selected funds during April 1999 through October 2021 (defining the first and last available semiannual intervals), we find that: Keep Reading

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