Equity Premium

Is the gap between the yield on the 10-year constant maturity U.S. Treasury note (T-note) and the 10-Year breakeven inflation rate (a measure of expected inflation over the next 10 years derived from T-note yield and 10-Year Treasury inflation-indexed constant maturity securities yield) indicative of future stock market or U.S. Treasury bond yields? To investigate, we relate monthly values of this gap (the expected real T-note gap) and changes in the gap to future monthly returns for SPDR S&P 500 ETF Trust (SPY) and iShares 20+ Year Treasury Bond ETF (TLT). Using monthly values for the four series during January 2003, limited by the breakeven inflation rate series, through July 2022, we find that: Keep Reading

Which variables deserve greatest focus when predicting stock market returns? In their July 2022 paper entitled “Searching for the Best Conditional Equity Premium Model”, Hui Guo, Saidat Sanni and Yan Yu exhaustively explore combinations of 18 previously identified potential stock market return predictors to isolate the most powerful subset. They focus on a best subset selection method with a penalty on complexity, thereby suppressing data snooping bias and selecting a manageable subset. For robustness, they consider four alternative variable selection methods. Using quarterly U.S. data for these 18 variables and S&P 500 Index levels/returns during 1947 through 2020, they find that: Keep Reading

Are the “Simple Asset Class ETF Value Strategy” (SACEVS) and the “Simple Asset Class ETF Momentum Strategy” (SACEMS) mutually diversifying. To check, based on feedback from subscribers about combinations of interest, we look at three equal-weighted (50-50) combinations of the two strategies, rebalanced monthly:

1. 50-50 Best Value – EW Top 2: SACEVS Best Value paired with SACEMS Equally Weighted (EW) Top 2 (aggressive value and somewhat aggressive momentum).
2. 50-50 Best Value – EW Top 3: SACEVS Best Value paired with SACEMS EW Top 3 (aggressive value and diversified momentum).
3. 50-50 Weighted – EW Top 3: SACEVS Weighted paired with SACEMS EW Top 3 (diversified value and diversified momentum).

We consider as a benchmark a simple technical strategy (SPY:SMA10) that holds SPDR S&P 500 ETF Trust (SPY) when the S&P 500 Index is above its 10-month simple moving average and 3-month U.S. Treasury bills (Cash, or T-bills) when below. We also test sensitivity of results to deviating from equal SACEVS-SACEMS weights. Using monthly gross returns for SACEVS, SACEMS, SPY and T-bills during July 2006 through July 2022, we find that: Keep Reading

A subscriber asked whether a rapid, large (20% or more) individual country currency devaluation versus the U.S. dollar indicates that the country’s stock market will rise the next quarter (with country exports presumably more competitive post-devaluation). To investigate, we select five currency exchange rates versus the U.S. dollar and relate monthly and quarterly changes in these rates to next-month and next-quarter total returns in U.S. dollars on exchange-traded funds (ETF) for respective country stock markets, as follows:

1. Malaysia: Ringgit to U.S. Dollar and iShares MSCI Malaysia ETF (EWM).
2. South Korea: Won to U.S. Dollar and iShares MSCI South Korea ETF (EWY).
3. Brazil: Real to U.S. Dollar and iShares MSCI Brazil ETF (EWZ).
4. China: Yuan Renminbi to U.S. Dollar and SPDR S&P China ETF (GXC).
5. India: Rupee to U.S. Dollar and iShares India 50 ETF (INDY).

We consider both linear relationships and outlier relationships (> 20% devaluations). Using monthly and quarterly changes/dividend-adjusted returns for the selected currency/equity ETF pairs as available (all limited by ETF histories) through June 2022, we find that: Keep Reading

Do exchange-traded funds (ETF) that hold convertible corporate bonds offer attractive performance? To investigate, we compare performance statistics for the following four convertible bond ETFs, all currently available, to those for a monthly rebalanced 60%-40% combination of SPDR S&P 500 ETF Trust (SPY) and iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD):

1. SPDR Bloomberg Convertible Securities ETF (CWB)
2. iShares Convertible Bond ETF (ICVT)
3. First Trust SSI Strategic Convertible Securities ETF (FCVT)
4. American Century Quality Convertible Securities ETF (QCON)

We focus on average return, standard deviation of returns, reward/risk (average return divided by 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 SPY and LQD over matched sample periods, all through June 2022, we find that: Keep Reading

How should global investors assess country sovereign bond and equity risks? In his July 2022 paper entitled “Country Risk: Determinants, Measures and Implications – The 2022 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

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 eight 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 Aware MSCI EAFE ETF (ESGD), with iShares MSCI EAFE ETF (EFA) as a benchmark
5. iShares ESG MSCI USA ETF (ESGU), with SPY as a benchmark.
6. Nuveen ESG Small-Cap ETF (NUSC), with iShares Russell 2000 ETF (IWM) as a benchmark.
7. Vanguard ESG U.S. Stock ETF (ESGV), with SPY as a benchmark.
8. 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, reward/risk (average return divided by 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 2022, we find that: Keep Reading

Multifactor funds offer rules-based, diversified exposures to firm/stock factors found to beat the market in academic studies. Do the funds beat the market in real life? In his June 2022 paper entitled “Multifactor Funds: An Early (Bearish) Assessment”, Javier Estrada assesses performance of such funds across U.S., global and emerging markets relative to that of corresponding broad capitalization-weighted indexes and associated exchange-traded funds (ETF). He focuses on multifactor funds with exposure to at least three factors that are explicitly marketed as multifactor funds. Using monthly total returns for 56 U.S.-based equity multifactor funds with at least three years of data and $10 million in assets from respective inceptions (earliest June 2014) through March 2022, and total returns for matched broad market indexes and ETFs, he finds that:

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A subscriber asked about the relationship between the high-yield bond spread and stock market return, with focus on when the latter is entering a bear market. To investigate, we use the ICE BofA US High Yield Index Option-Adjusted Spread (HY Spread) as a proxy for the high-yield bond spread and SPDR S&P 500 ETF Trust (SPY) as a proxy for the U.S. stock market. We look at the following interactions between HY Spread and SPY:

• Daily lead-lag correlations between HY Spread/change in HY Spread and SPY return.
• Monthly lead-lag correlations between HY Spread/change in HY Spread and SPY return.
• Average next-month SPY return by range of monthly changes in HY Spread.
• Monthly changes in HY Spread before the worst next-month SPY returns.
• Next-month SPY returns after the biggest monthly jumps in HY Spread.

Using daily values of HY Spread and daily dividend-adjust SPY prices from the end of December 1996 (limited by HY Spread) through mid-June 2022, we find that: Keep Reading

Are preferred stock strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider seven of the largest preferred stock ETFs, all currently available, in order of longest to shortest available histories:

• Invesco Financial Preferred (PGF) – generally invests at least 90% of assets in preferred securities of financial institutions.
• iShares Preferred and Income Securities (PFF) – tracks an index composed of U.S. dollar-denominated preferred and hybrid securities.
• Invesco Preferred (PGX) – tracks performance of fixed-rate preferred securities issued in the U.S.
• SPDR ICE Preferred Securities (PSK) – seeks exposure to non-convertible preferred securities with par $25 and aggregate minimum par value $250 million.
• VanEck Vectors Preferred Securities ex Financials (PFXF) – tracks performance of U.S. exchange-listed hybrid debt, preferred stock and convertible preferred stock issued by non-financial corporations.
• First Trust Preferred Securities and Income (FPE) – normally invests at least 80% of assets (including borrowings) in preferred securities and income-producing debt securities, including corporate bonds, high-yield securities and convertible securities.
• Global X U.S. Preferred (PFFD) – invests in a broad basket of U.S. preferred stocks.

We use a monthly rebalanced portfolio of 60% SPDR S&P 500 (SPY) and 40% iShares iBoxx $ Investment Grade Corporate Bond (LQD) (60-40) as a simple hybrid benchmark for all these funds except PGF, for which we use Financial Select Sector SPDR (XLF). We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using monthly returns for the preferred stock ETFs and benchmarks as available through May 2022, we find that: Keep Reading