http://osam.com/Commentary/factors-from-scratch
Factors from Scratch:
A look back, and forward, at how, when, and why factors work
By Jesse Livermore*, Chris Meredith, CFA, and Patrick O’Shaughnessy, CFA
May 2018
Shows the performance contribution of underlying fundamentals and market valuation to portfolios of value stock, glamour stocks, recent winners, and recent losers.
Value: They find that value stocks do have deteriorating fundamentals, losing 16.8% EPS average during a 1 year rebalancing period. The stocks should have been priced at a 40% P/E discount relative to the market to account for the coming deterioration but were priced at a 50% discount instead. The subsequent reversion to fair prices more than overcomes the EPS losses.
They don't see evidence of value being arbitraged away, as value stocks still trade at significant discounts. They suspect recent underperformance has been due to uncharacteristic weakness in value stocks compared to the strength in growth stocks. That should be written down as a permanent loss for the strategy, not a coiling of the spring that will lead to especially strong future outperformance.
Regression of relative value shows no relationship to future value strategy returns once outliers are removed.
Momentum: Portfolios of recent winners have the opposite features of value - they generate strong EPS growth (better than 4th quintile P/E companies but they avoided discussing top quintile because they often have negative EPS) and trade at premiums that are 10% above what would be justified by that growth. However, they tend to become even more expensive for the first year to 19% overvalued. Momentum captures a divergence away from fair value while Value captures a convergence back to fair value. Then after the first year momentum stocks start falling in valuation back towards fair value and would generate underperformance if the strategy didn't rebalance.
(They didn't dive much into a portfolio of 1-2 year lagged losers, which I suspect based on their momentum findings would work as a good pseudo-value factor.)
Relative value had absolutely no relationship with future momentum strategy returns.
*pseudonym of the philosphicaleconomics author
Submitted June 03, 2018 at 05:01PM by kiwimancy https://ift.tt/2LWSWkL
