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Value Investing Strategy (Strategy Overview)

Allocations for March 2024 (Final)
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Momentum Investing Strategy (Strategy Overview)

Allocations for March 2024 (Final)
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Investing Expertise

Can analysts, experts and gurus really give you an investing/trading edge? Should you track the advice of as many as possible? Are there ways to tell good ones from bad ones? Recent research indicates that the average “expert” has little to offer individual investors/traders. Finding exceptional advisers is no easier than identifying outperforming stocks. Indiscriminately seeking the output of as many experts as possible is a waste of time. Learning what makes a good expert accurate is worthwhile.

Compendium of Live ETF Factor/Niche Premium Capture Tests

Some exchange-traded funds (ETF) focus on capturing potentially attractive factor premiums or thematic niches. Their histories offer a way to test these concepts live. We have conducted many such tests, listed here to offer a global view.

  1. “U.S. Equity Premium?” – evidence from simple tests on about 21 years of data suggests that stock market leadership shifts between the U.S. and other developed markets over time, but the U.S. may be better overall.
  2. “Tech Equity Premium?” – evidence from simple tests on 24 years of data suggests long boom, short bust for a tech/innovation-concentrated portfolio. It does not support belief in risk-adjusted outperformance.
  3. “Measuring the Size Effect with Capitalization-based ETFs” – evidence from simple tests of capitalization-based ETFs with nearly 22 years of data offers little support for belief in a long-term, reliably exploitable size effect among U.S. stocks.
  4. “Do Equal Weight ETFs Beat Cap Weight Counterparts?” – evidence from simple tests on some equal-weight U.S. equity ETFs offers little support for belief that equal weighting substantially and reliably beats capitalization weighting on a net basis.
  5. “Measuring the Value Premium with Value and Growth ETFs” – evidence from simple tests with 21.6 years of available data does not support belief that investors reliably capture a value premium via popular value-growth ETFs.
  6. “Are Equity Momentum ETFs Working?” – available evidence on attractiveness of momentum-oriented U.S. stock and sector ETFs is less than compelling.
  7. “Are Stock Quality ETFs Working?” – available evidence offers little support for belief that quality ETFs reliably beat respective benchmarks.
  8. “Are Low Volatility Stock ETFs Working?” – available evidence on attractiveness of low volatility stock ETFs is mixed, with recent data undermining belief in reliability of low volatility outperformance.
  9. “Are Equity Multifactor ETFs Working?” – available evidence offers very little support for belief that equity multifactor ETFs beat their benchmarks, or that they offer material diversification with comparable performance.
  10. “Are Hedge Fund ETFs Working?” – evidence on attractiveness of hedge fund-oriented ETFs is mostly negative.
  11. “Are Managed Futures ETFs Working?” – available evidence on attractiveness of managed futures ETFs in aggregate (but with recent short-sample exceptions) suggests that any benefits from diversification of equities and fixed income are unlikely to compensate for poor absolute returns.
  12. “Best Safe Haven ETF?” – evidence from simple tests over available and common sample periods suggests that silver, gold, longer-term U.S. Treasuries and investment grade corporate bonds are safe havens, while crude oil is clearly not.
  13. “Do High-dividend Stock ETFs Beat the Market?” – evidence from data for high-dividend U.S. stock ETFs does not support belief that high-dividend stocks reliably outperform the broad U.S. stock market.
  14. “Are ESG ETFs Attractive?” – available evidence suggests that ESG ETFs do not perform much differently from selected benchmarks.
  15. “How Are Renewable Energy ETFs Doing?” – available evidence on attractiveness of renewable energy ETFs is adverse overall, but with bursts of market outperformance perhaps due to novelty.
  16. “How Are Robotics-AI ETFs Doing?” – available evidence is that robotics-AI ETFs are less attractive than the broader technology exposure offered by QQQ.
  17. “How Are AI-powered ETFs Doing?” – available evidence does not support belief that ETFs using AI to select and weight assets are particularly attractive.
  18. “Are iShares Core Allocation ETFs Attractive?” – available evidence regarding attractiveness of iShares Core Asset Allocation ETFs is mixed to negative.
  19. “Are Target Retirement Date Funds Attractive?” – evidence offers little support for belief that target retirement date mutual funds are preferable to simple stocks-bonds diversification.
  20. “How Are TIPS ETFs Doing?” – available evidence on attractiveness of TIPS ETFs is mostly favorable after the recent inflation burst, with shorter duration funds offering more reliable inflation protection.
  21. “Are Equity Index Covered Call ETFs Working?” – available evidence on attractiveness of equity index covered call ETFs as either substitutes for or diversifiers of underlying stock indexes is generally adverse.
  22. “Are Equity Put-Write ETFs Working?” – available evidence on attractiveness of equity put-write ETFs is adverse.
  23. “Are IPO ETFs Working?” – available evidence on attractiveness of IPO ETFs is mixed, requiring very high risk tolerance of interested investors.
  24. “Are Preferred Stock ETFs Working?” – available evidence on attractiveness of preferred stock ETFs relative to a 60-40 stocks-bonds portfolio is largely negative.
  25. “Do Convertible Bond ETFs Attractively Meld Stocks and Bonds?” – available evidence suggests that convertible bond ETFs sometimes outperform and sometimes underperform a conventional 60-40 stocks-bonds portfolio.
  26. “Do ETFs Following Gurus/Insiders Work?” – available evidence on attractiveness of guru/insider-following stock ETFs is mostly adverse.
  27. “Congressional Trade Tracking ETFs” – limited available evidence suggests that investors should choose a fund mimicking holdings of Democrat rather than Republican members of Congress.
  28. “The Long and Short of Jim” – available evidence does not support belief that funds based on Jim Cramer’s stock/market recommendations reliably produce attractive short-term returns.
  29. “Live Test of the Stock Market Overnight Move Effect” – early evidence does not support belief in exploitability of the overnight move effect.

The upshot of the above items is that academic factor research and thematic speculations rarely translate to outperformance when implemented with ETFs.

A global caution is that the period since 2009 is strong for broad equity indexes, driven by a few large-capitalization firms. This trend may not persist.

How Are AI-powered ETFs Doing?

How do exchange-traded-funds (ETF) that employ artificial intelligence (AI) to pick assets perform? To investigate, we consider six such ETFs, all currently available, as follows:

We use SPDR S&P 500 ETF Trust (SPY) for comparison, though it is not conceptually matched to some of the ETFs. We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using monthly total returns for the six AI-powered ETFs and SPY as available through January 2024, we find that: Keep Reading

Test of Some Motley Fool Public Stock Picks

A reader asked: “I am wondering how come you have not rated Motley Fool guys. Any insight?” To augment the test of Motley Fool public stock picks in “‘Buy These Stocks for 2019’ Forward Test”, we look at three more lists of stock picks:

  1. “10 Top Stocks That Will Make You Richer in 2021” published 1/5/2021: Alphabet (GOOG), Amazon (AMZN), Costco Wholesale (COST), Cresco Labs (CRLBF), Kirkland Lake Gold (KL), NextEra Energy (NEE), salesforce.com (CRM), Teladoc Health (TDOC), UnitedHealth Group (UNH) and Visa (V).
  2. “7 Stocks That Could Make You Richer in 2022” published 1/5/2022: Devon Energy (DVN), Innovative Industrial Properties (IIPR), Mastercard (MA), PayPal (PYPL), Sea Limited (SE), Teladoc Health (TDOC) and Vertex Pharmaceuticals (VRTX).
  3. “Got $1,000? 5 Sensational Stocks to Buy to Start 2023 With a Bang” published 12/26/22: AstraZeneca (AZN), Broadcom (AVGO), Innovative Industrial Properties (IIPR), NextEra Energy (NEE) and Novavax (NVAX).

We calculate total (dividend-reinvested) returns for the first list during 1/5/2021 through 12/31/2021, for the second list during 1/5/2022 through 12/30/2022 and for the third list during 12/30/22 through 12/29/23. We compare average returns of these lists to returns for SPDR S&P 500 ETF Trust (SPY) over matched sample periods. Using dividend-adjusted closing prices for SPY and each of the stocks in the three lists on the specified dates from Yahoo!Finance, except for Kirkland Lake Gold, for which prices are from Barchart.com, we find that:

Keep Reading

20 Great Stock Ideas for 2023?

In late 2022, Forbes “tapped Morningstar to identify top-performing fund managers who have either beat their benchmarks this year or on a longer-term basis over three-year, five-year or ten-year periods. Here are their best stock ideas for the coming year…” as published at the beginning of January 2023 in “20 Great Stock Ideas for 2023 from Top-Performing Fund Managers”:

Air Lease (AL)
Atlanta Braves Holdings Inc Series C (BATRK)
Becton Dickinson (BDX)
Bill.com Holding (BILL)
CACI International (CACI)
Chord Energy (CHRD)
Comcast (CMCSA)
Dish Network (DISH)
DoubleVerify (DV)
Duolingo (DUOL)
HCA Healthcare (HCA)
Insulet (PODD)
Permian Basin Royalty Trust (PBT)
Philip Morris International (PM)
Royal Caribbean Cruises (RCL)
Shopify (SHOP)
TJX (TJX)
UnitedHealth Group (UNH)
Waste Connections (WCN)
Zebra Technologies (ZBRA)

How did these ideas perform? To check, we collect end-of-2022 and end-of-2023 dividend-adjusted prices for the 20 ideas and calculate the annual total return for each. We then compare the average of these returns to the annual total return for SPDR S&P 500 ETF Trust (SPY). Using the specified annual data for 2022 and 2023, we find that:

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ChatGPT Prediction of News-related Stock Market Returns

Is ChatGPT useful for predicting stock market returns based on financial news headlines? In the December 2023 version of their paper entitled “ChatGPT, Stock Market Predictability and Links to the Macroeconomy”, Jian Chen, Guohao Tang, Guofu Zhou and Wu Zhu investigate whether ChatGPT 3.5 can predict U.S. stock market (S&P 500 Index) returns based on Wall Street Journal front-page news headlines/alerts. The instruction they give ChatGPT 3.5 is:

“Forget all previous instructions. You are now a financial expert giving investment advice. I’ll give you a news headline, and you need to answer whether this headline suggests the U.S. stock prices are GOING UP or GOING DOWN. Please choose only one option from GOING UP, GOING DOWN, UNKNOWN, and do not provide any additional responses.”

They first compute monthly ratios of good news to total news (NRG) and bad news to total news (NRB) and then relate these ratios to S&P 500 Index excess returns over the next 1, 3, 6, 9 or 12 months. They compare the ability of ChatGPT to predict returns to that of traditional human interpretation and to those of BERT and RoBERTa as ChatGPT alternatives. Using daily Wall Street Journal front-page news headlines/alerts and monthly S&P 500 Index excess returns during January 1996 through December 2022, they find that:

Keep Reading

Equity Factor Timing from Deep Neural Networks

Can enhanced machine learning models accurately time popular equity factors? In their January 2024 paper entitled “Multi-Factor Timing with Deep Learning”, Paul Cotturo, Fred Liu and Robert Proner explore equity factor timing via a multi-task neural network model (MT) to capture the commonalities across factors and a dynamic multi-task neural network model (DMT) to extract financial and macroeconomic states. They attempt to time six well-known factors: (1) excess market return, size, value, profitability, investment and momentum. They employ 272 model inputs (123 macroeconomic and 149 financial) to predict each month:

  1. The sign of next-month return for each factor.
  2. The return for an equal-weighted portfolio that holds the factors (the risk-free asset) for factors with positive (negative) predicted returns.

The compare performances of MT and DMT with those of seven simpler off-the-shelf machine learning models: logistic regression (LR), penalized logistic regression (EN), random forest (RF), extremely randomized trees (XRF), gradient boosted trees (GBT), support vector machine (SVM) and feed-forward neural network (NN). For all models, they use the first 20 years of their sample period for training, the next five years for validation and the remaining years for out-of-sample testing. Their benchmark is an equal-weighted portfolio of all six factors. Using monthly data for the 272 model inputs and monthly returns for the six factors during January 1965 through December 2021, with out-of-sample testing starting January 1990, they find that: Keep Reading

ChatGPT Interpretation of Firm Earnings Calls

Can ChatGPT find red flags in firm earnings calls? In their January 2024 paper entitled “Unusual Financial Communication – Evidence from ChatGPT, Earnings Calls, and the Stock Market”, Lars Beckmann, Heiner Beckmeyer, Ilias Filippou, Stefan Menze and Guofu Zhou test the ability of ChatGPT-4 Turbo to identify and analyze unusual content and tone aspects of S&P 500 earnings calls. Unusualness has 25 dimensions derived from executive behaviors, analyst questions, specific content or technical issues. They examine correlations of unusualness with firm characteristics, industry and macroeconomic indicators across business cycles. They validate unusualness by looking at associated stock returns and trading volumes from one day before through one day after earnings calls. Using transcripts of S&P 500 earnings calls from Refinitiv, firm characteristics/stock trading data and macroeconomic data during January 2015 through December 2022, they find that:

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Profitable Machine Learning Stock Picking Strategies?

Can machine learning models pick stocks that unequivocally generate alpha out-of-sample? In their November 2023 paper entitled “The Expected Returns on Machine-Learning Strategies”, Vitor Azevedo, Christopher Hoegner and Mihail Velikov assess expected net returns and alphas of machine learning-based anomaly trading strategies. They use nine machine learning models to predict next-month stock returns based on inputs for up to 320 published anomalies, added to the mix according to respective publication dates:

They train the models using an expanding window, with the last seven years reserved for six years of validation and one year of out-of-sample-testing. During the test year, they each month reform a portfolio that is long (short) the value-weighted tenth, or decile, of stocks with the highest (lowest) predicted next-month returns. They then calculate actual next-month gross returns and 6-factor (market, size, value, profitability, investment and momentum) alphas during the test year. To calculate net returns and alphas, they multiply trading frictions estimated from historical bid-ask spreads times monthly portfolio turnovers. Using returns and firm characteristics for a broad sample of U.S. common stocks having data covering at least 20% of the 320 anomalies during March 1957 through December 2021, with out-of-sample tests starting January 2005, they find that:

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Understandable AI Stock Pricing?

Can explainable artificial intelligence (AI) bridge the gap between complex machine learning predictions and economically meaningful interpretations? In their December 2023 paper entitled “Empirical Asset Pricing Using Explainable Artificial Intelligence”, Umit Demirbaga and Yue Xu apply explainable artificial intelligence to extract the drivers of stock return predictions made by four machine learning models: XGBoost, decision tree, K-nearest neighbors and neural networks. They use 209 firm/stock-level characteristics and stock returns, all measured monthly, as machine learning inputs. They use 70% of their data for model training, 15% for validation and 15% for out-of-sample testing. They consider two explainable AI methods:

  1. Local Interpretable Model-agnostic Explanations (LIME) – explains model predictions by approximating the complex model locally with a simpler, more interpretable model.
  2. SHapley Additive exPlanations (SHAP) – uses game theory to determine which stock-level characteristics are most important for predicting returns.

They present a variety of visualizations to help investors understand explainable AI outputs. Using monthly data as described for all listed U.S stocks during March 1957 through December 2022, they find that:

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Causal Discovery Applications in Stock Investing

Can causal discovery algorithms (which look beyond simple statistical association, and instead consider all available data and allow for lead-lag relationships) make economically meaningful contributions to equity investing? In their December 2023 paper entitled “Causal Network Representations in Factor Investing”, Clint Howard, Harald Lohre and Sebastiaan Mudde assess the economic value of a representative score-based causal discovery algorithm via causal network representations of S&P 500 stocks for three investment applications:

  1. Generate causality-based peer groups (e.g., to account for characteristic concentrations) to neutralize potentially confounding effects in long-short equity strategies across a variety of firm/stock characteristics.
  2. Create a centrality factor represented by returns to a portfolio that is each month long (short) peripheral (central) stocks.
  3. Devise a monthly network topology density market timing indicator.

Using daily and monthly data for S&P 500 stocks and monthly returns for widely used equity factors during January 1993 through December 2022, they find that: Keep Reading

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