It’s called “Crisis Investing: How to Maximize Returns During Market Panics.” It’s the first thing I’ve read that explains why the kind of investing we do–quantitative value investing–works best during times of economic crisis and doesn’t work so well during bull markets. Moreover, it’s well written and well researched, and there are factors suggested in it that you may not be aware of. There’s even some excellent material about high-yield bond investing.
The idea here is that you don’t. Using a combination of value, quality, low volatility, size (lower better), and momentum should work OK in a bull market (you might not always have excess returns, but it’s relatively safe), but it should work gangbusters in a crisis period, as has been shown by the authors’ research into those periods. The idea is to stick with that combination through thick and thin, not to time the switch.
Exactly, Factor diversification is the name of the game and they work o.k. in bull markets and work great after a DD in a crisis.
Also very good to know that the fear of DDs is irrational, good models need Market DDs because especially Small Caps get sold
emotionally to extreme levels (e.g. very good valuations) and that creates the opportunities for diversified factor models.
Georg,
I think the newsletter you are referring to has one glaring fault. Its says “The stock market should be a reflection of actual economic growth.”.
It is expected economic growth and earnings that the market prices to in the future. And this is currently being drivien by government policies for corporate taxes and lesser business regulation.
IMHO, the market is expecting for Trump to win in 2020, for the US Senate to remain Republican and for the general corporate environment to remain positive. If the market believes that Trump will lose, even if it is a moderate and business friendly candidate like Mike Bloomberg, then expected economic growth and earnings will go down, driving prices down.
O.K., I have found the definition High Yield Spread in the referenced article:
The solid line is the difference between the high yield bond rate and the corresponding rate for the highest quality firms (AAA rated). The dotted line is the difference between the high yield rate and the rate on ten year Treasury Bonds.
Overall both spreads move closely together. As it turns out, our empirical results do not
depend on which spread we use.
So I guess the High Yield Spread in P123 syntax:
##corpBBB - ##UST10YR
Plotting this, one finds that the critical spread referred to in the VERDAD article of 6.5% does not happen very often. In fact in the last 15 years it only was present for 70 days in 2008 and 2009. So that’s when you go for the recommended asset allocation.
Perhaps they use ##corpBB - ##UST10YR
That gives a bigger spread, but still does not reach 6.5% in 2010, 2012, and 2016. For those years you get max spread of 4.4%, 4.5%, and 5.2%, respectively. That is for stocks trading on NYSE.
I found what is being used by VERDAD for the high yield spread. it is ##corpB.
Rule for an Aggregate Series:
UnivAvg(“True”,“(EMA(3,0,##corpB) - EMA(3,0,##UST10YR))”)
The link in the paper is to another paper defining the high-yield spread as the spread between high-yield and investment-grade bonds. AAA, AA, A, and BBB are investment grade; BB, B, and the various C bonds are high-yield. ##CorpB is a lot better than ##CorpBB, but is still a little low. Perhaps the best is ICE BofA US High Yield Index Effective Yield (BAMLH0A0HYM2EY) | FRED | St. Louis Fed . . . For investment grade bonds, we can use ICE BofA AAA US Corporate Index Effective Yield (BAMLC0A1CAAAEY) | FRED | St. Louis Fed . . .
If a crisis is a spread of 6.5% or more, this gives crisis dates of
10/23/2000 - 3/19/2002
6/10/2002 - 4/1/2003
8/20/2008 - 10/13/2009
9/22/2011 - 10/20/2011 (less than a month)
1/15/2016 - 2/29/2016
