Larry Swedroe: The Value Effect And Macroeconomic Risk

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Random Walker
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Larry Swedroe: The Value Effect And Macroeconomic Risk

Post by Random Walker » Sat Jan 13, 2018 4:23 pm

https://alphaarchitect.com/2018/01/09/t ... omic-risk/

Good article where Larry reviews literature showing that the value premium is related to several macroeconomic variables: industrial production, credit spreads, term spreads, unexpected inflation. Value stocks are substantially more risky during bad economic times than growth stocks and moderately more risky during good economic times. During bad times value stock prices get hit harder and the expected return increases. As the economic environment improves, the spread between value and growth declines, value does relatively better, and future expected value premium lessens.
At both the beginning and end of the article Larry reminds us that the value premium likely has both risk based and behavioral based components to it. There is another thread started in last few days asking whether factor investing is “skating where the puck was”. I don’t think so. The market prices risk and markets are very efficient. Thus I believe the value premium is not going away. I buy the behavioral story as well. Larry’s quote that the value premium is not a free lunch, but perhaps involves a free stop at the dessert tray makes strong sense to me. Eager to hear what others think.

Dave

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nedsaid
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Re: Larry Swedroe: The Value Effect And Macroeconomic Risk

Post by nedsaid » Sun Jan 14, 2018 1:11 am

Random Walker wrote:
Sat Jan 13, 2018 4:23 pm
https://alphaarchitect.com/2018/01/09/t ... omic-risk/

Good article where Larry reviews literature showing that the value premium is related to several macroeconomic variables: industrial production, credit spreads, term spreads, unexpected inflation. Value stocks are substantially more risky during bad economic times than growth stocks and moderately more risky during good economic times. During bad times value stock prices get hit harder and the expected return increases. As the economic environment improves, the spread between value and growth declines, value does relatively better, and future expected value premium lessens.
At both the beginning and end of the article Larry reminds us that the value premium likely has both risk based and behavioral based components to it. There is another thread started in last few days asking whether factor investing is “skating where the puck was”. I don’t think so. The market prices risk and markets are very efficient. Thus I believe the value premium is not going away. I buy the behavioral story as well. Larry’s quote that the value premium is not a free lunch, but perhaps involves a free stop at the dessert tray makes strong sense to me. Eager to hear what others think.

Dave
Since the 2008-2009 financial crisis and bear market, the Value premium has been on an extended vacation save for 2016. I have been paying for my desserts so to speak. My expectation is that Value will return with a vengeance but I don't know when.

Larry mentions that Value does better when the economy does better but the 1990's were good economic times and Growth left Value in the dust. So there seem to be exceptions to everything.

The thing is, there is a quality aspect to the factors. For example, the size factor seems to have disappeared but when you use a good Small-Cap Index that does some screening for quality, the size factor returns with a vengeance. Larry has discussed how DFA has improved its Value funds by not only screening Momentum from negative to neutral but also by adding Profitability/Quality. Even the "black hole of investing", small growth does pretty well if you screen out the "lottery stocks."

We talk about increased returns for increased risk, this is only true to a point. Otherwise we would all be lottery millionaires. There would be a lot of penny stock millionaires. There is a point at which you get diminishing returns for taking on more and more risk, at that point more risk is less return. So you have "Value traps" on the Value side of the market and those "Lottery stocks" in the growth side of the market, particularly Small Growth.

So there is pretty good evidence that you improve both Size and Value if you also do some Quality screening. Screen out the junk and results improve. One reason the S&P 500, the S&P Mid-Cap 400, and the S&P Small-Cap 600 do so well. US Total Market tilts a bit to quality because successful companies have larger market caps than do unsuccessful companies, the top 100 companies are just over 50% of the US Stock Market capitalization. Market cap weighting bakes Quality into the broad indexes and screens out what I call the "anti-factors."

The "anti-factors" include the value traps and the lottery stocks.
A fool and his money are good for business.

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