The sophisticated asset-pricing models we have today allow us to determine the underlying sources of returns to investments. Specifically, they permit us to identify the factors to which an investment has exposure. However, a problem arises when employing current asset-pricing models to consider alternative, illiquid investments. The volatility of such assets is often understated. This…
On Oct. 29, the Federal Reserve announced the official end to its bond-buying program, otherwise known as quantitative easing (QE). Given all the debate about the efficacy of the Fed’s policy decisions, and the stomach acid created by the many dire forecasts about what was going to happen when quantitative easing ended, I thought it…
One of the more persistent investment myths holds that a winning strategy is to sell stocks in May and wait to buy back into the market until November. While it is true that stocks have provided greater returns from November through April than they have from May through October, the equity risk premium has still…
The municipal bond market has almost $4 trillion in total debt outstanding. That compares with about $18 trillion in outstanding U.S. Treasury debt. Besides market size, municipal bonds differ from Treasurys in that they carry credit risk, are less liquid and are exempt from federal income tax. The size of the spread between Treasury bonds…
Let’s define “popular” as being liked or admired by the general public. One might reasonably think that popularity is a good thing, right? But when it comes to investing, research shows popularity often comes with lower returns. This correlation can sometimes result in a conflict with traditional economic theory, where risk and expected return should…
Earlier this week, we discussed some of the academic literature surrounding historical versus current valuations as a metric for forecasting future returns. We learned that because there’s so much variation over time in the equity risk premium, there isn’t any methodology that will produce highly accurate forecasts of stock returns. Stocks are risky investments, no…
At a recent meeting with a nonprofit organization, my firm was asked to explain why we don’t consider historical stock returns the best estimator of future returns. They wanted to understand why we instead rely on our own forecasts. Their request came in part because another firm had suggested in a previous pitch that forecasts…
The stock premium, the annual average return of stocks minus the annual average return of one-month Treasury bills, has historically been high. This fact has, understandably, attracted investors to the stock market. For the period 1927-2013, the stock premium averaged 8.18 percent. There has also been a size premium (the return of small stocks minus…
Today we’ll take a look at how the size and value premiums performed in 12 recessions, identified as such by the National Bureau of Economic Research, occurring in the post-World War II era. During that period, the average length of a recession was 11 months. Size Premium While the size premium from 1926 through 2013…
There is a wide body of evidence demonstrating the existence of momentum not only in stocks, but across asset classes. There’s also evidence that moving-average indicators provide higher risk-adjusted stock returns in recessions. On the other hand, while major data vendors, such as MarketWatch and Bloomberg, report daily on technical market indicators (for example, advance…
Today we’ll turn our attention to the two risk premiums that help explain the performance of bond portfolios—term and credit. Unlike with the value premium, there’s no debate about whether these two factors earn premiums based on risk. They are not anomalies created by behavioral errors. The data covers the same 87-year period, 1927-2013, that…
Recently, we have seen a rise in the level of discussion about whether there is a significant value premium in large-cap stocks. The value premium is the tendency of stocks with low prices relative to measures of their value to outperform stocks with high relative prices. Since large-cap stocks make up about 90 percent of…
It’s now been more than five years since our last recession. This most recent recession, caused by the financial crisis, officially began in December 2007 and lasted until June 2009, a period of 18 months. It was the longest of 12 recessions, identified as such by the National Bureau of Economic Research, occurring in the…
A large majority of investors have seen their portfolios underperform simple buy-and-hold strategies, despite having followed the stock-picking and market-timing advice of so-called experts. These “experts” include pundits, gurus and forecasters such as Bill Gross, John Hussman, Nouriel Roubini, Meredith Whitney and, yes, even Jim Cramer. Investors confronting subpar returns are left wondering, “What went…
The academic literature is filled with challenges to the efficient markets hypothesis. Perhaps the greatest among these challenges involves the existence of momentum and the poor performance of small-growth stocks and high-beta stocks. Beta is defined as the measure of the systematic risk of a security or a portfolio in comparison to the market as…