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After Value, Dividend And Quality, Momentum Has Also Started To Lag

Summary Large groups of Value, Dividend and Quality stocks have been lagging the market for one year. Momentum was a good place to hide until September. The last weeks have been harmful for Dividend and Quality stocks. A previous article published on 9/1 pointed out that groups of stocks broadly selected on value, dividend and quality criteria have been lagging the benchmark since the 3rd quarter of 2014. To spare you the time of reading it, this was the conclusion: In the recent months, a wide outperformance of momentum stocks has been detrimental to value, dividend and quality stocks. The recent correction was beneficial to dividend stocks excess return, but value and quality are still lagging. This fashion in momentum explains why a lot of investors with portfolios based on value and quality factors have underperformed the market in the recent months. The trend started in June 2014, and accelerated in June and July 2015. This phenomenon is not limited to a small group, it is widely spread in the 100 best stocks of the S&P 500 index (NYSEARCA: SPY ) in each investing style category. These categories are simplified by taking the top 20% of the S&P 500 ranked on a unique factor. The top 20% of value stocks is defined as the 100 S&P 500 stocks with the lowest price/earnings ratio (P/E trailing 12 months, excluding extraordinary items). The top 20% of dividend stocks is defined as the 100 S&P 500 stocks with the highest yield. The top 20% of quality stocks is defined as the 100 S&P 500 stocks with the highest return on equity (ROE trailing 12 months). The top 20% of momentum stocks is defined as the 100 S&P 500 stocks with the highest price increase in 1 year (250 trading days). Variations in the relative performance of such large groups of stocks may be random on short periods. When they are consistent on long periods, they denote a behavioral change in the market. My aim here is to observe and quantify this change, not to explain it. Hereafter you can see the equity curves and statistics of the four “top 20%” groups for the last 3 months. The lists are updated and equal-weighted on market opening of the first trading day every week. Dividends are reinvested. Top 20% Value: (click to enlarge) Top 20% Dividend: (click to enlarge) Top 20% Quality: (click to enlarge) Top 20% Momentum (click to enlarge) The next table gives the annualized excess return over SPY of the top 20% group for each category since 1/1/1999, then on the last 12 months, 6 months, 3 months and 1 month. Annualized excess return of the top 20% stocks in… Since 1999 Last 12 months Last 6 months Last 3 months Last month Value 6.89% -7.67% -12.58% -10.4% -12.99% Dividend 5.37% -4.22% -5.93% -2.6% -34.16% Quality 4.91% -2.53% -7.49% -9.69% -30.14% Momentum 3.63% 4.45% 6.45% -2.2% -16.64% The long term outperformance of all groups confirms that investors following any of these investing styles can get a positive statistical bias. This has been documented in countless academic publications. Value investing has an edge over other styles. However, value stocks have been lagging for more than 1 year (since June 2014 exactly). The sector meltdown in energy and some basic materials companies is an incomplete explanation: it is accountable for less than half of the negative excess return of value stocks on this period. The relative loss has accelerated a bit in the last month. Dividend and quality stocks have also been lagging for at least one year, and their underperformance has accelerated considerably in the last month. Momentum stocks have been outperforming their own historical excess return for at least 1 year, but they did worse than SPY in the last 3 months, and especially in the last month. Conclusion Until September, we could interpret the situation as a transfer of excess return from value, quality and dividend to momentum. Lately, momentum has also underperformed and the benchmark index has done better than the 4 groups of stocks representing classic investing styles. After looking at data before the 2 major downturns since 1999, my previous article concluded that such patterns don’t seem to be clues to identify a market top. There are cycles of variables amplitudes and time frames in asset classes, sectors and investing styles. On the long term, value, dividend, quality and momentum offer a statistical bias. On the short term, investors following quantitative or discretionary strategies based on these styles may experience more frustration before getting back their edge. Updates I plan to publish updates on investing styles performance. If you don’t want to miss the next one, click “follow” at the top of this article. Data and charts: portfolio123

Investors Favor Equity ETFs In 2015

By Patrick Keon Positive net flows into equity exchange-traded funds (ETFs) (+$55.5 billion) have far outweighed those into equity mutual funds (+$6.9 billion) for the year to date. Investors putting more net new money into equity ETFs as opposed to equity mutual funds has been true for every year except one (2013) since the global financial crisis. What jumps out about this year’s fund flows activity for equity ETFs is that nondomestic equity ETFs have dominated equity ETFs. Nondomestic equity ETFs have grown their coffers by almost $64 billion so far for 2015, while domestic equity ETFs have seen over $8 billion leave. If this trend holds through year-end, 2015 will be the first year since 2010 that nondomestic equity funds have had more net inflows than domestic ones. Nondomestic barely nudged out domestic for most net inflows for 2010 (+$34.0 billion versus +$33.7 billion), while the roughly $70-billion spread for this year would be by far the highest annual difference between the two groups for the 20 years Lipper has been tracking the data. It stands to reason then that nine of the ten largest net inflows among equity ETFs this year have been for nondomestic products. These nine ETFs are split up between MSCI EAFE (4), Europe (3), and Japan (2) products. The MSCI EAFE ETFs have taken in the most net new money (+$24.3 billion) of the three groups, followed closely by Europe ETFs (+$21.6 billion), with the Japan products recording more-modest gains (+$8.5 billion). The single largest positive net inflows belong to Deutsche X-trackers MSCI EAFE Hedged Equity ETF ( DBEF , +$12.9 billion). Conversely, the largest equity ETFs are two S&P 500 Index products: SPDR S&P 500 ETF Trust ( SPY , $168.0 billion of assets under management) and iShares Core S&P 500 ETF ( IVV , $63.8 billion of assets under management); each has seen money leave this year. SPY has had net outflows of almost $36 billion for YTD 2015, while IVV is down $1.1 billion.

Index ETF Investors Are Vulnerable To A Return To Rational Pricing

Recent financial research suggests that inclusion of a corporate share in an index ETF adds to its market value. As index ETF investor participation grows, overpricing apparently becomes more pronounced. As ETF participation has become a greater share of the investment universe, these effects have apparently become more important. As a result index ETFs may now be both less diversified and overvalued. A return of shares included by ETFs to their fundamental, rationally determined, values would adversely impact an index ETF investment. The effect of the new valuations on index ETF decision-making would be perverse, leading to further investor losses. According to much recent financial research, the market’s focus on index ETFs [such as the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), the iShares Core S&P 500 ETF (NYSEARCA: IVV ) and the Vanguard Total Stock Market ETF (NYSEARCA: VTI )] has led to overpricing of many of the common shares included in the important indexes, accompanied by underpricing of companies excluded by the indexes, among other pricing anomalies. This mispricing presents a hazard to investors. The only existing investor defense against a return of these overpriced stocks to their rational value is to buy underpriced stocks outside the index ETF with properties similar to the overpriced stocks inside the ETF. How can the simple publication of an index number intended to represent the value of the stock market as a whole change the value of common stocks? The indexes that are the subject of this article are the source of the dominant common stock investment strategy of the moment, the index ETF. For example the Standard and Poors 500 Stock Index (S&P, a value-weighted average of the 500 largest common shares listed on the NYSE or NASDAQ) is the oldest and still the most important example of a traded numerical characterization of the value of the equity market as a whole. Index exchange traded funds (ETFs) are exchange-listed instruments that replicate broad market measures such as the S&P. Index ETFs are big – about 30% of the volume of all investment funds under management. But there may be strange effects of the existence of index ETFs on the prices of stocks that are part of an index. Those effects, or at least the current scholarly take on them, is chronicled in an interesting October 10th article in the New York Times . The Times article points to substantial evidence produced by market researchers that common stocks included in the popular listed indexes are often, by all the usual measures, overvalued relative to similar stocks outside the indexes. In the current financial academic literature, this is a prominent example of market irrationality. It is not rational, the argument goes, for the simple inclusion of a stock in an index portfolio to change investor behavior and thus affect market prices of securities so profoundly. But the evidence points to several effects. It has been clear, almost since the S&P 500 index began to be published, that being newly included in an important index increases a stock’s market value; while a fall into exclusion leads to a decline in market value. But there is evidence of other more profound effects as well. It appears that as a greater share of the market is included in index portfolios, the effects of index inclusion on stock prices have become more pronounced. And the effects may not simply be higher prices of stocks within the indexes, but higher correlations among the prices of stocks within the indexes as well. This higher correlation is particularly interesting, since it has investor risk management implications. If higher past correlation continues, the major indexes no longer perform their function in portfolio theory – risk reduction through diversification. Why? If correlation between investments inside the indexes rises, correlation among instruments outside the indexes rises, and correlation between index-included and index-excluded investments falls, a diversified portfolio must include stocks outside the index. In other words, the behavior of stocks in index ETFs creates a paradox. The effect of index ETF growth is that the index no longer represents a diversified portfolio. Index ETFs are, in this sense, self-defeating. To form a truly diversified portfolio, investors must now add other stocks outside the ETF. The index ETFs are vulnerable to any trading strategy that exploits this mispricing. One trading strategy that a hedge fund might apply to restore rational pricing to the stock market has characteristics that can be found in my SA Instablog: ” A Trading Strategy Based on Index ETF Overpricing. An ETF Defense. ” Investors can protect themselves (imperfectly) now from a return to rational pricing of the shares included by the index ETFs, and simultaneously achieve the portfolio diversification index ETFs once provided, by buying diversified shares outside the ETFs.