It’s Always Darkest Just Before Dawn
Wide divergences between the valuations of cheap stocks relative to expensive stocks have preceded significant outperformance for value over the subsequent decade, as shown in this figure.
Factor Returns and the Information in Valuation Spreads
Given that valuations provide information on equity returns, it should not be surprising to learn that valuation spreads provide information on future factor premiums.
Should investors be indifferent to dividend impact on stock returns?
In their 1961 paper, “Dividend Policy, Growth, and the Valuation of Shares,” Merton Miller and Franco Modigliani famously established that dividend policy should be irrelevant to stock returns. As they explained it, at least before frictions like trading costs and taxes, investors should be indifferent to $1 in the form of a dividend (causing the stock price to drop by $1) and $1 received by selling shares. This must be true, unless you believe that $1 isn’t worth $1. This theorem has not been challenged since, at least in the academic community.
Improving ESG Practices Boosts Valuations
This chart on creating shareholder value through ESG engagement is useful when evaluating if ESG practices boost valuations.
Mitigating Risks with Factor Strategies
The following exhibit, which is useful to the subject of mitigating risks with factor strategies, provides the total return of the four benchmark portfolios and the five anomaly portfolios.
The Value Factor and Deleveraging
How do you separate the signal from the noise? To have confidence that a factor premium, or strategy, isn’t just the result of data mining - a lucky/random outcome - we recommended that you should require evidence that the premium has been not only persistent over long periods of time and across economic regimes, but also pervasive across sectors, countries, geographic regions and even asset classes; robust to various definitions (for example, there has been both a value and a momentum premium using many different metrics); survives transactions costs; and has intuitive risk- or behavioral-based explanations for the premium to persist.
Expected Returns to Green Stocks
The past decade has seen a dramatic growth in sustainable investing—applying environmental, social and governance (ESG) criteria to investment strategies. Investments considered environmentally friendly are often referred to as “green,” while “brown” denotes the opposite. Important questions for investors are: What are the expected returns to green stocks? What does their past performance tell us about their future expected returns? We begin by looking at what economic theory tells us our expectations should be.
The Performance of Multi-Factor Long-Short Portfolios in Various Economic Regimes
To determine if a multi-factor approach has provided diversification benefits in terms of exposure to economic cycle risks, the research team at Counterpoint evaluated returns to multifactor long-short strategies, stocks, and 1-month T-bills in a variety of economic conditions (recession or no recession, high or no high inflation, and stagflation) over the period July 1963-August 2022.
The “Resurrected” Size Effect and Monetary Policy
Given that tightening monetary policy increases economic risks, Simpson and Grossman provided compelling evidence of a risk explanation for the size factor. For those investors who engage in tactical asset allocation strategies (market timing), their evidence suggests that it might be possible to exploit the information. Before jumping to that conclusion, I would caution that because markets are forward-looking, they should anticipate periods of Fed tightening and the heightened risks of small stocks.
Trend Following and Relative Sentiment: Complementary Factors
Since it is likely that both the Relative Sentiment and Trend Following strategies will underperform at some points in the future, “a 50-50 combination of TF and RS might reduce the emotional volatility an investor may experience from holding only the underperforming strategy.”
Active Managers are Subject to the Same Biases as Individual Investors
Are active managers victims of the same bias as individual investors? That is the question we’ll explore in this paper.
Market Risk and Speculative Factors
Soroush Ghazi and Mark Schneider authors of the August 2022 study “Market Risk and Speculation Factors” decomposed the excess market return (the equity risk premium) into speculative (in the simple sense that it is negative, reflecting a premium investors pay to hold assets that are more subject to speculative demand) and non-speculative, or risk (in the simple sense that it is positive, a necessary characteristic for a factor to reflect compensation for risk) components.
Mind the Momentum Gap to Improve Performance
This article discusses the academic research about the Momentum Gap and the role that its predictive potential may have in reducing momentum crashes, hence possibly improving performance.
The Effect of Indexing on Price Discovery and Limits to Arbitrage
We discuss the academic research about the causal effect of indexing on arbitrage conditions and price discovery.
Lottery Demand and the Asset Growth Anomaly
It is well documented in the literature that over the long term, low-investment firms have outperformed high-investment firms—with the negative relation between asset growth (AG) and future stock returns particularly featured by the overvaluation of high AG stocks.
Momentum Everywhere, Including Emerging Markets
Atilgan et al. contribute to the momentum literature with “Momentum and Downside Risk in Emerging Markets.”
The Relationship Between the Demand for Leverage and Management Fees
This article discusses what academic research says about the relationship between the demand for leverage and management fees.
High-Frequency Consumer Spending Data and the Cross-Section of Stock Returns
Consumer demand drives the cash flows of consumer-oriented companies. Thus, they should serve as a reliable source of information to predict future fundamentals above and beyond the information contained in financial statements and readily available market data.
The Short-Duration Equity Premium
We examine the short-duration premium using pre-scheduled economic, monetary policy, and earnings announcements. We provide high-frequency evidence that duration premia associated with revisions of economic growth and interest rate expectations are consistent with asset pricing models but cannot explain the short-duration premium. Instead, we show that the trading activity of sentiment-driven investors raises prices of long-duration stocks, which lowers their expected returns, and results in the short-duration premium. Long-duration stocks have the lowest institutional ownership, exhibit the largest forecast errors at earnings announcements, and show the highest mispricing scores.
Brand Values and Long-Term Stock Returns
An equal-weighted portfolio of Best Brands (BBs) in the U.S. earns an excess return of 25 to 35 bps per month during the period 2000-2020. This result is remarkably robust across various factor models and therefore is not driven by exposure to common (risk) factors. The excess returns of the BB portfolio are not due to firm characteristics, industry composition, or small-cap stocks. We provide evidence suggesting that expensing investments in brands (instead of capitalizing them) and the tendency to underestimate the effect of brand name on generating future earnings are two mechanisms contributing to the excess returns.