Equity Premium

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

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:

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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

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:

• Cyclical:
  • Materials Select Sector SPDR (XLB)
  • Industrial Select Sector SPDR (XLI)
  • Consumer Discretionary Select SPDR (XLY)
  • Vanguard Small Capitalization Index Fund (NAESX)
• Defensive:
  • Consumer Staples Select Sector SPDR (XLP)
  • Utilities Select Sector SPDR (XLU)
  • Health Care Select Sector SPDR (XLV)

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

How meaningful is the term Environmental, Social, and Corporate Governance (ESG) as a descriptor of firm valuation and investment performance? In his November 2021 paper entitled “ESG: Hyperboles and Reality”, George Serafeim assesses beliefs about ESG, including those involving firm valuation and ESG firm/fund investment performance. Drawing on more than a decade of research, he concludes that: Keep Reading

Is the conventional way of estimating the equity risk premium based on total shareholder return (TSR, assuming reinvestment of all dividends into stocks) reasonable? In their November 2021 paper entitled “Stock Investors’ Returns are Exaggerated”, Jesse Fried, Paul Ma and Charles Wang examine the realism of TSR as a measure of aggregate U.S. equity investor performance and therefore as the basis for U.S. equity premium estimation. They define an alternative all-shareholder return (ASR) that explicitly incorporates feasible reinvestment possibilities for cash distributions. Specifically, ASR:

• Rejects the infeasible total dividend reinvestment assumption and alternatively assumes shareholders reallocate dividends into U.S. Treasuries of different maturities, corporate bonds or housing.
• Takes into account all sources of cash flows from firms to investors, including repurchases and equity issuances (net distributions).

Using monthly estimated returns and cash distributions for the U.S. stock market and returns for the specified alternatives for cash distribution during January 1926 through December 2015, they find that: Keep Reading

Do U.S. non-farm job openings, a measurement from the Job Openings and Labor Turnover Survey run monthly by the U.S. Bureau of Labor Statistics, have implications for future U.S. stock market return? High (low) job openings rate may indicate a strong (weak) economy and/or may signal high (low) wage inflation. To investigate, we relate job openings to performance of SPDR S&P 500 (SPY) as a proxy for the stock market. Using monthly job openings (which has a release delay of about six weeks) during December 2000 through September 2021 and monthly dividend-adjusted returns for SPY during December 2000 through October 2021, we find that: Keep Reading

Do quarterly allocation updates for the Best Value and Weighted versions of the “Simple Asset Class ETF Value Strategy” (SACEVS) work as well as monthly updates? These strategies allocate funds to the following asset class exchange-traded funds (ETF) according to valuations of term, credit and equity risk premiums, or to cash if no premiums are undervalued:

3-month Treasury bills (Cash)
iShares 20+ Year Treasury Bond (TLT)
iShares iBoxx $ Investment Grade Corporate Bond (LQD)
SPDR S&P 500 (SPY)

Changing from monthly to quarterly allocation updates does not sacrifice information about lagged quarterly S&P 500 Index earnings, but it does sacrifice currency of term and credit premiums. To assess alternatives, we compare cumulative performances and the following key metrics for quarterly and monthly allocation updates: gross compound annual growth rate (CAGR), gross maximum drawdown (MaxDD), annual gross returns and volatilities and annual gross Sharpe ratios. Using monthly dividend-adjusted closes for the above ETFs during September 2002 (earliest alignment of months and quarters) through September 2021, we find that:

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Does the U.S. employment quit rate, a measurement from the Job Openings and Labor Turnover Survey run monthly by the U.S. Bureau of Labor Statistics, have implications for future U.S. stock market or U.S. Treasury bond return? A high (low) quit rate may indicate a strong (weak) economy and/or may signal high (low) wage inflation. To investigate, we relate quit rate to future performance of SPDR S&P 500 (SPY) as a proxy for the stock market and of iShares 20+ Year Treasury Bond (TLT) as a proxy for government bonds. Using monthly quit rate (which has a release delay of about six weeks) during December 2000 through August 2021 and monthly dividend-adjusted returns for SPY and TLT as available during December 2000 through September 2021, we find that: Keep Reading

What is the best way to understand and anticipate variations in equity factor returns? Past research emphasizes factor return connections to business cycle variables or measures of investor sentiment (with little success). In his September 2021 paper entitled “The Quant Cycle”, David Blitz analyzes factor returns themselves to understand their variations, arguing that behavioral rather than economic forces drive them. He determines the quant cycle (bull and bear trends in factor returns) by qualitatively identifying peaks and troughs. He focuses on U.S. versions of four conventionally defined long-short factors frequently targeted by investors (value, quality, momentum and low-risk), emphasizing the most volatile (value and momentum). He also considers some alternative factors. Using monthly data for factors from the online data libraries of Kenneth French, Robeco and AQR spanning July 1963 through December 2020 (and for a reduced set of factors spanning January 1929 through June 1963), he finds that:

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