Larry Swedroe: Factors Linked To Business Cycles

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Random Walker
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Larry Swedroe: Factors Linked To Business Cycles

Post by Random Walker » Fri Feb 02, 2018 9:47 am

http://www.etf.com/sections/index-inves ... nopaging=1

Larry reviews a paper that looks at behavior of factors in relation to yield curve inversions and stages of recessions. Correlations between factors are low and the correlations change through the stages. Timing factors may well not be productive, but this paper I think certainly lends support to strategically diversifying across them.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by lazyday » Fri Feb 02, 2018 2:35 pm

In the table "Cumulative Returns for 6 Factors Across Economic Stages (%)" I'm a bit surprised that the worst returns for RMW is during a recession. These companies are better equipped to survive reduced sales volume or prices. I'd expect them to be much less likely to have negative earnings.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by nisiprius » Fri Feb 02, 2018 2:52 pm

This would be very useful information to me if I could predict the business cycle.

The National Bureau of Economic Research (NBER), mentioned in the article, not only will not predict when a recession is coming, it will not even tell you whether we are in one. As far as they are concerned, nothing definitive can be said about a recession until after it is actually over.

If I can't predict recessions, then I don't see how I can exploit any information about which factors do well in various stages of a recession.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by Random Walker » Fri Feb 02, 2018 5:04 pm

Nisiprius,
If you can’t predict recessions, but diversifying across factors appears productive during them, correlations change, can’t time factors, wouldn’t that be a case for diversifying across all factors all the time and sticking to the plan?

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by Theoretical » Fri Feb 02, 2018 5:54 pm

lazyday wrote:
Fri Feb 02, 2018 2:35 pm
In the table "Cumulative Returns for 6 Factors Across Economic Stages (%)" I'm a bit surprised that the worst returns for RMW is during a recession. These companies are better equipped to survive reduced sales volume or prices. I'd expect them to be much less likely to have negative earnings.
I've been pretty skeptical of the gross profitability/Quality argument myself, but I think it does lend some support to the idea that it's a risk factor because there are higher expectations placed on those companies, so a decrease in earnings or the other maladies a recession brings adversely affect the stock price, even though the company is still relatively better off as a business than its junky/low profitability cousin. Kind of a "higher place to fall" sort of risk. It's a pretty weak argument.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by nisiprius » Fri Feb 02, 2018 9:03 pm

Random Walker wrote:
Fri Feb 02, 2018 5:04 pm
Nisiprius,
If you can’t predict recessions, but diversifying across factors appears productive during them, correlations change, can’t time factors, wouldn’t that be a case for diversifying across all factors all the time and sticking to the plan?

Dave
Larry Swedroe sent me a PM making a similar point, and the closing paragraph of his article makes it, too.
The bottom line is that the most prudent strategy is for investors to build portfolios that are strategically (as opposed to tactically) diversified across factors that show persistence in their premiums, have low correlation to other factors, are pervasive around the globe and across asset classes, have intuitive reasons to believe the premiums should persist (whether behavioral-based or risk-based) and are implementable (meaning they survive transaction costs).
However, the paragraph just before the last one seems to hedge a little, by suggesting that a style-timing strategy is "tempting."
As tempting as the proposition might be, there doesn’t seem to be enough convincing evidence that a style-timing strategy can be expected to be profitable going forward. With that said, if you are going to “sin” by trying to time factors, I’d recommend following Asness’s advice to “sin a little.”
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by Random Walker » Fri Feb 02, 2018 9:10 pm

I don’t have a clue where I’d start if I were to try to “sin a little” with factors. That’s probably a good thing, should keep me out of trouble :-)

Dave

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by nedsaid » Fri Feb 02, 2018 9:42 pm

Random Walker wrote:
Fri Feb 02, 2018 9:10 pm
I don’t have a clue where I’d start if I were to try to “sin a little” with factors. That’s probably a good thing, should keep me out of trouble :-)

Dave
This forum is my confession booth where I confess my investing sins. I own individual stocks, a few load funds, and active funds. I have dabbled in factor investing. And yes, I have market timed in its mildest forms. I do have a lot of money indexed but less than half of my portfolio. So I have sinned more than a little, at least by Boglehead standards.
A fool and his money are good for business.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by gips » Fri Feb 02, 2018 10:09 pm

I would love for someone to present proof that factor-based investing (including implementation cost) outperforms the russell 2000 on a risk-adjusted basis.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by patrick013 » Fri Feb 02, 2018 10:32 pm

gips wrote:
Fri Feb 02, 2018 10:09 pm
I would love for someone to present proof that factor-based investing (including implementation cost) outperforms the russell 2000 on a risk-adjusted basis.
Anything could beat the 2000, factor based or not.
Last I heard...but it is still an age old index. Not
aware of any current stats but just recent performance.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by AlohaJoe » Fri Feb 02, 2018 10:50 pm

gips wrote:
Fri Feb 02, 2018 10:09 pm
I would love for someone to present proof that factor-based investing (including implementation cost) outperforms the russell 2000 on a risk-adjusted basis.
How exactly does someone "prove" such a thing? We can't even "prove" that stocks outperform bonds on a risk-adjusted basis.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by willthrill81 » Fri Feb 02, 2018 11:01 pm

nedsaid wrote:
Fri Feb 02, 2018 9:42 pm
Random Walker wrote:
Fri Feb 02, 2018 9:10 pm
I don’t have a clue where I’d start if I were to try to “sin a little” with factors. That’s probably a good thing, should keep me out of trouble :-)

Dave
This forum is my confession booth where I confess my investing sins. I own individual stocks, a few load funds, and active funds. I have dabbled in factor investing. And yes, I have market timed in its mildest forms. I do have a lot of money indexed but less than half of my portfolio. So I have sinned more than a little, at least by Boglehead standards.
Don't feel badly. Being a trend follower (albeit with index funds whenever possible), I 'sin' heavily and regularly! :wink:
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by GreatOdinsRaven » Fri Feb 02, 2018 11:33 pm

patrick013 wrote:
Fri Feb 02, 2018 10:32 pm
gips wrote:
Fri Feb 02, 2018 10:09 pm
I would love for someone to present proof that factor-based investing (including implementation cost) outperforms the russell 2000 on a risk-adjusted basis.
Anything could beat the 2000, factor based or not.
Last I heard...but it is still an age old index. Not
aware of any current stats but just recent performance.

You might find this article interesting. S&P 600 vs R2000
"The greatest enemies of the equity investor are expenses and emotions." -John C. Bogle, Little Book of Common Sense Investing. | | "Winter is coming." Lord Eddard Stark.

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by lazyday » Sat Feb 03, 2018 5:52 am

Theoretical wrote:
Fri Feb 02, 2018 5:54 pm
I've been pretty skeptical of the gross profitability/Quality argument myself, but I think it does lend some support to the idea that it's a risk factor because there are higher expectations placed on those companies, so a decrease in earnings or the other maladies a recession brings adversely affect the stock price, even though the company is still relatively better off as a business than its junky/low profitability cousin. Kind of a "higher place to fall" sort of risk. It's a pretty weak argument.
I do have trouble seeing it as a risk that should be compensated.

Another argument I've seen is that high margins attract competition, so you risk lower earnings when they come. But this still seems less risky to me than having low margins.

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BuyAndHoldOn
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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by BuyAndHoldOn » Sat Feb 03, 2018 6:33 am

These articles are always interesting. To me, they reinforce the need to buy and hold. What you have bought - if it is a good investment - will do well, but it may not show up on paper all the time.

That Market Beta basically means you could hold inversely correlated bonds [to stocks/the economic cycle] and just re-balance during a recession. Doesn't sound so hard, yet I feel like it is :oops:

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Re: Larry Swedroe: Factors Linked To Business Cycles

Post by nedsaid » Sat Feb 03, 2018 1:03 pm

willthrill81 wrote:
Fri Feb 02, 2018 11:01 pm
nedsaid wrote:
Fri Feb 02, 2018 9:42 pm
Random Walker wrote:
Fri Feb 02, 2018 9:10 pm
I don’t have a clue where I’d start if I were to try to “sin a little” with factors. That’s probably a good thing, should keep me out of trouble :-)

Dave
This forum is my confession booth where I confess my investing sins. I own individual stocks, a few load funds, and active funds. I have dabbled in factor investing. And yes, I have market timed in its mildest forms. I do have a lot of money indexed but less than half of my portfolio. So I have sinned more than a little, at least by Boglehead standards.
Don't feel badly. Being a trend follower (albeit with index funds whenever possible), I 'sin' heavily and regularly! :wink:
I remember Dick Fabian and his 200 day moving average. A friend of mine followed his newsletter and he would calculate the moving average daily for his mutual fund holdings. As I recall, when the price was above the moving average, you were in an uptrend and that would be a "buy" signal. When prices moved below the moving average, you would sell. Pretty much, the strategy was built on the old saying about the trend being your friend. There is a certain element to Newtonian physics in this, what is in motion tends to stay in motion. Another way of saying it is that there is a bandwagon effect in the markets, or momentum.

It is interesting that momentum has been studied by the academics and it is a real phenomenon. I was very surprised to find that of all the factors that momentum is the most reliable and persistent. So there is something to this. It seems that momentum strategies are like riding the wave, it helps a lot to get off the wave before it crashes. Of course, momentum in a positive direction doesn't last forever as a security or sometimes the entire market just runs out of buyers. So momentum is subject to crashes every so often and there is momentum on the downward side as well. To fully capture this effect, one needs to short also though long only Momentum funds work but cannot capture the entire factor premium.
A fool and his money are good for business.

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