Many fundamental investors have been shaped by Peter Lynch.? Invest from the bottom up.? Analyze companies, not the economy. Time spent on analyzing the economy is wasted time.
This book takes the opposite approach.? If you understand the economy, and think you know how GDP growth and inflation will go, you have a better chance of choosing the right industries and outperforming.
Like my methods of investing, he looks to understand where we are in the business cycle.? After that, look for good companies that exploit the tailwind.
I became familiar with the main author in the mid-2000s, when he worked for ISI Group.? I appreciated his approach to the markets, which was similar to mine, as the bubble grew, and he and I warned about it.
Think of it this way.? If you had been reading the main author in mid-2006, and had listened to him, how much better off would you be now?? Considerably better off and I offer many warnings over at RealMoney.com before the crisis emerged.
The book will help you understand the sectors and factors in the market that affect returns, and what elements lead those returns.
Beyond that the book expresses skepticism over many of the current economic policies of the US and other governments amid the overindebtedness of much of the world.
At the end, rather than saying, “This is what you should do,” the book asks what your views are, and says if you believe in “such and so” as an economic future, this is what you ought to do.
I liked the book a lot.? I think it is of value to most fundamental investors.
Full disclosure: The publisher sent me a copy of the book for free.
If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
I think this is a stupid idea.? (I don’t favor the CAPM either.)? When you borrow money to buy some asset, the distribution of possible returns changes.
Let me give you some analogies.?? First, securitization.? Those that invest in non-senior loan tranches get an enhanced yield, but they face a different risk profile than most corporate bond investors.? Corporate bond investors have a high expectation of full payment, but when default occurs, they lose 60-80%.? Investors in securitized bonds rarely get recoveries.? They usually get paid in full or lose it all.
Second, think of banks or REITs.? They lever up safe assets, and they blow up with a higher frequency than do industrial corporate bonds.
Leverage changes the nature of the distribution of possible returns in three ways:
The cost of borrowing decreases the return.
The returns are levered by the amount of borrowing.
To the degree that others do the same thing, the strategy is no longer undiscovered, and superior returns should not be expected.? In a crisis, the borrowed money leads to overshoots as panicked investors bail out en masse.
Personally. I wish we could get rid of the writings of academic economists and finance writers that don’t actively invest.? They don’t get the dynamics of investing, and assume a simple world that does not resemble our world.
My main point is that trying to buy the asset class with the highest return after equalizing volatilities is a fool’s bargain.? Adding leverage changes the nature of decisionmaking, and what tests in the lab will not likely work in real life.? Paper trading does not always translate to real world profits.
How do we estimate what returns are reasonable to expect?? Most investment counselors fall back on easy rules of thumb, but is there a way of doing better?
In this book, the author takes academic research on investment returns, and tries to make it practical.? What are the main findings of the book?
Momentum works.
Value works.
Illiquid assets can work very well if you have a balance sheet that can hold them.
Carry strategies work most of the time, but when they fail, they fail big.? Same for strategies that sell volatility.
The book does a very good job in establishing that the excess returns of stocks over bonds are a lot lower than most believe.? It also supports the idea that moderate risk taking is the superior strategy.? Those that take high risks lose too often.? Those who take no risk don’t make anything significant.? Moderate risk-taking is the sweet spot.
One of the strengths of the book is that it considers almost all assets, and analyzes how many factors affect those asset classes.? The book is comprehensive; it covers everything, even if it is only an inch deep in spots.
I liked this book a lot, but it’s not for everyone.? You won’t find a lot of difficult math here, but you will find a lot of numbers.
Quibbles
I don’t agree with the idea of levering up low risk assets.? Yes, if you are? the only one doing it, fine, be a non-regulated pseudo-bank.? The trouble comes when many do it.? Eventually a liquidity crisis hits, and those levering up low risk assets get hosed.
The same is true of university endowments.? Too many thought it was easy money to invest in illiquid assets, and when the liquidity panic came in 2008-2009, they were forced to borrow, and/or sell illiquid assets at an inopportune time.
The book does cover everything, but it doesn’t cover everything deeply.? I think it is a valuable book to most who do asset allocation, but the author knows his limits, and does not claim to be expert in a number of areas.
Full disclosure: The publisher sent me a copy of the book for free.
If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
The graph above is the S&P 500 on the right axis with a logarithmic scale, and 4-, 6- and 20-day average absolute percentage price change on the the left axis, linear scale.? As you can see, high price volatility is associated with bear market bottoms.
In terms of 4- and 6-day volatility, this market ranks third in the last 61 years, behind 1987 and 2008.? Wait another three weeks for the 20-day volatility, it could be competitive with 2008 and 1987.? 1987 was sharper and shorter than 2008 because there weren’t any systemic risk issues involved, as there are in 2008 and 2011.
Isn’t it fascinating that the volatility level is so high now — what makes this period of time so special compared to the overvaluations of 1987 or the overleverage of 2008?? I think it is overleverage again, though valuations are somewhat high.
There are many people out there following aggressive investment strategies, but they want to be covered if things go wrong.? Why not sell down the positions a little and buy some high quality short-to-intermediate-term bonds?
What!?! Give up the upside?!? They would rather buy some insurance — something that will pay off big if things go bad.
But think of the other side of the trade.? What does the one offering you insurance have to do?? It depends if they are scrupulous or unscrupulous.
Scrupulous: Set aside money or high quality assets in reserve, and treat the premiums as part of the the return on a high-yield money market fund, albeit with the possibility of a severe loss.
Unscrupulous: Don’t set anything aside.? Write as many contracts as you can.? It’s free money because there won’t be any crash.? And if there is a crash, declare bankruptcy.? After all, many others will be doing the same thing — you will have company.
Even if the contracts in question are exchange-traded, with margin posted, still the one writing the contracts and taking the risk should be ready to pay the whole wad in the disaster scenario.? Maybe the exchange will make up a few small defaults, but even exchanges can go broke if the situation is severe enough.
In order for tail risk to be mitigated fairly, someone must keep a supply of slack high quality assets.? Rather than the insurer doing that, why not have the investor do so?? The insurer brings along his own cost structure.? Why not self insure and bring down the risk level directly.? Someone has to hold high-quality assets to mitigate risk; let the investor be that party; embracing simplicity and enjoying reduced risk without the possibility of counterparty failure.
Quaint, huh?? And it doesn’t involve a single disgusting derivative, unlike those that would create a “Black Swan” ETF.
I want to thank Geoffrey Ching for spotting an error in my post How to Make More Returns on REITs.? He even came up with what I did wrong; my signal was off by one month, producing returns way too good to be true.? So is the strategy wrong?
No.? It’s still a good strategy, just not astounding.? Here’s the double quintile for mortgage REITs:
And for equity REITs:
Here’s the return graph for equity REITs:
And that for mortgage REITs:
It feels intuitively right that Mortgage REITs don’t beat equity REITs, even with a better strategy for both.? The momentum strategy boosts? the returns on mortgage REITs from 5.1% to 11.1%.? For Equity REITs it moves from 12.0% to 14.0%.
I don’t wonder at this result.? Indeed, my shame is that I didn’t probe the last result more.? This is still useful for those who would pursue momentum, just not as useful as the first article.? And with that, I apologize to my readers for my prior error.? It is my policy to correct errors once I am convinced of them.
Before I start this evening, I want to offer corrections to my last piece on REITs.? Sorry, data glitch, and the results are a little different but the conclusions are unchanged.
Here is the correct regression for Mortgage REITs:
And the the correct regression for equity REITs:
Why the change?? The main difficulty was that the first set of regressions was disaligned time-wise because the twenty-year Treasury yield was not estimated by the Fed for about ten years.? This calculation adjusts for that.? Interesting that when you use the correct data, mortgage REITs fit less well.? That’s an odd happenstance.? Equity REITs, are around the same — though the t-statistics look worse because I included two more points on the curve.
But now to the point of tonight’s piece.? After my last piece, one reader said:
This sounds like an interesting scenario to use your grid analysis, where your quantiles might be ranked using (1) equity/mortgage REIT spreads and (2) monetary policy (measured by either short term rates or yield curve slope).
I decided to try it, except for one thing.? I thought that using the spreads or yields in quintiles would have too much information about the future that if an investor knew the limits of how high or low yields could go, it would be too simple.? The surprise was this: I tried it for fun, and it was no better than what I will show you.
I chose two variables:
Yield curve slope, measured by twenty-year yield less one-year yield
Momentum, measured by amount the price is over the ten-month moving average.
I divided both up by quintiles, reasoning that an investor focused on momentum and the yield curve would have enough data from history prior to 1972 to generalize what would be favorable and unfavorable conditions for investment.
Here is what I found for Mortgage REITs:
and what I found for Equity REITs:
Both data series? confirmed one idea.? Momentum matters.? (Now the yield curve matters, but not so much.)? So I constructed a rule to be invested in REITs if they were in the third momentum quintile or higher, or be invested in one year Treasuries otherwise.
So what were the results?? Equity REITs:
The difference in returns is 20.8%/year following the strategy versus 12.0% not following the strategy.
Now what for Mortgage REITs, that properly despised subindustry group?
The difference in returns is 22.4%/year following the strategy versus 5.1% not following the strategy.
The bizarre result is that though equity REITs trounced mortgage REITs? over 38+ years as indexes, the momentum strategy makes mortgage REITs do better then equity REITs.? That is probably because the returns on mortgage REITs are more autocorrelated — they streak more.
I just say wow, and wonder at it all.? I have some daily models for interest-rate sensitive sectors that I haven’t trotted out yet, which switch between mean reversion and mean aversion that do better than this, but I don’t believe them because they are too good.? It is possible to trip onto something parsimonious that explains history if you are smart enough.? I prefer stuff where I have a theory behind it, as with momentum, where people are slow to catch on.
Now, after all of this, I will tell you I have no money riding on this.? None. Nada. Null.?? Part of this is that it would not be so good when implemented in real-time, and mortgage REITs are a thin industry.? More of it comes from an aversion to what might happen if/when momentum investing becomes pervasive.? We had a taste of that in Summer 2007, where momentum strategies blew up for a short time.? For those willing to see it through, though, it did not amount to much.
So long as? momentum is an incidental strategy to the market, it can work well.? It can never be the main strategy of the market lest matters go totally nuts.
Every 100 posts, I take a step back and try to think about where we have been over the last five months.? The investment world has been bullish, favoring stocks and commodities, and not bonds.? Money market rates have been driven to zero or so. (Have they tried to bill you yet for holding your money? 😉 )
I have a wide array of interests, which is what makes my blog a little different.? I’ve been doing more with stock and bond investing, which reflects the work that I do, but I still have time for commentary on Macroeconomics, banking regulation, and monetary policy.? I know that there are few who want to read everything I write, but there are many who want to read a few things I write.
The biggest things I have written recently have been:
That doesn’t count RSS and the many places where my blog is syndicated. I’m relatively free with my content.? But if you are reading me elsewhere, if you want to make a comment, please come to my site.? I do not interact with readers outside of my own site, and that includes Seeking Alpha.? I don’t have time for it, so if you want my attention, come to my site.
Away from blogging, my asset management business has launched.? let me quote from an e-mail to a more successful friend of mine:
I have had a lot of lessons over the past four months, and I don?t think they are over.
1) Unrealistic expectations: partly because there was quite a lag between my announcement and my start up, a lot of people that I think lost interest because of the lag.? But when I talked with other investment advisors later, they told me I had:
More prospects than I should reasonably expect for a new advisor, and
A better conversion percentage of prospects to clients than most, and
Chosen an underserved section of the market ($100-500K).
So, after four months, I am managing a little more money than my own assets at the firm, with about 12 clients, and 5 more on the way.
2) I did not realize that I would need to create fixed income management so early.? But for those that can?t hedge, I had to have another way of reducing equity market risk.? No track record there, but a lot of experience doing it, both with bonds and ETFs.
3) The most common objection of potential customers is that the market is too high, and so they don?t want to invest.? Still more asked for a Tactical Asset Allocation strategy, which I eventually created.? No telling whether it will work well, or build assets.
4) Custodial issues have not been absent.? Getting set up with Interactive Brokers is more difficult than with most because everything is automated; if one thing is wrong, it rejects and you have to try again.? Once Interactive Brokers is set up though, things work easily, the trading tools are great, and they are cheap, especially for clients in $100-500K range.? So I try to help clients as much as I can going in; so far, so good, with a little annoyance to me and clients.
Aside from that, I have been underperforming of late.? Not by much, but it feels bad to be missing the benchmark with the money of others.? I did not enter this business to lose.? After beating for so many years, it is a test to be missing now, largely because my posture is the most conservative it has been for the last eleven years.Anyway, that?s how I am doing.? I think I will reach viability by the end of 2012, but who can tell?
Indeed who can tell, but I got another new client today, equal to my largest external client, and there may be more if I do well.? I am grateful for their confidence.? Hey, perhaps one day I might get investors larger than me.? I hope so.? If I get to double my current size, I will try to hit up the emerging manager funds — there aren’t many emerging managers with 11 year track records.? And from there, who can tell?
I have an intern (child #7) and she is a very bright young woman who wants to learn investing.? She may have the “gene” that I got from my mom, but she sees this as the best way to be economically productive as a future wife and mother.? My Mom and Dad were equals economically, though Dad’s work made more difference early with his work — Mom earned more in the later years from the investing.? Give Mom credit for wisdom, and Dad credit for setting her free to do it (more or less).
I am enjoying this a lot, and am not worried about recent underperformance.? It has always corrected in the past, and then some.? If nothing else, it makes me work harder.? I like working hard.
I am a firm believer in “you can’t get something for nothing.”? So it is when a new derivative is proposed.? Either there are natural counterparties to take up the exposure (reducing their risk), or speculators must be encouraged to take the risk (more likely).
So, with longevity derivatives, the risk is people living too long leading to more pension payments in future years.? The proposition is: find a party that is willing to make more payments if mortality is better than expected, and offer him a payment, or series of payments, as an inducement to enter the transaction.
Let’s think for a moment, what entities benefit from a rise in longevity?? I can think of one: life insurers.? But there is a problem: anti-selection.? People who buy life insurance tend to be sicker than those of the general population, who tend to be sicker than annuitants.? Annuitants live the longest, and their lifespans improve the most on average.? Life insurers would find taking on longevity risk to be a dirty hedge at best for their life insurance books.? In general there have been few reinsurance agreements for longevity risk for immediate annuity portfolios, but then, that would be a really small component of the life insurance industry at present.
Even when terminal funding was permitted (back in the 1980s to early 90s) — where plan sponsors could buy annuities from insurers to free themselves from their pension obligations, it typically wasn’t a big business, and what did get done transferred credit risk from the plan sponsor to the participant.? Life insurer insolvency means the pension is at risk, subject to the limits of the state guaranty funds.? An acquaintance of mine, who was an actuary, who partially lost a pension on such an insolvency, said the solution wasn’t that hard — allow a lump sum as an option to those for whom the obligation was being transferred from plan sponsor to insurer.
The terminal funding business ceased because of changes in IRS regulations because a few companies realized gains out of terminating their plans.? That sat ill with Congress, especially past the era of corporate raiders, so an excise tax dramatically reduced the business.
So, even when pension plans were able to use insurers to reduce/eliminate their liabilities, there were issues.? There will be issues for longevity derivatives as well.
A swap agreement could point to a “reference portfolio of lives” chosen from some neutral database, or could point to the actual lives that the plan sponsor is trying to hedge.? The first requires less underwriting, and can be more generic, the second has less basis risk, and solves the actual problem, but requires messy underwriting.
Swap agreements could be long or short, but if I were a plan sponsor, I would have a hard time deciding whether to do a long or short swap.? Long swap: counterparty risk.? Short swap: little risk relief.? And to me, long would be 30 years or more and short would be ten years or less.? On short swaps if I ended up on the winning side of the trade, I would probably find few new takers for swaps when the time period was up.
That leaves me with one idea that might work: use a long (~30 years) cat-bond-type structure, where the principal adjusts down as deaths occur.? But we still have the counterparty issue.? If it is the obligation of a operating corporation, there is credit risk.? If it is its own bankruptcy remote Special Purpose Vehicle (SPV – no recourse to a parent company), then there is the risk that the assets in the SPV might not earn the returns necessary over the long haul to pay the interest and redeem the principal.
Calling Ajit Jain.? This is one of those contingencies that yearns for a Buffett-like investor who has a strong balance sheet and can invest for the long haul with above average returns, and thus absorb the volatility of aging annuitants.
But such balance sheets and investors are few.? So I would submit the idea that if you could not get Berkshire Hathaway to issue longevity bonds through such a structure as I have described, you’ll have a hard time issuing long dated longevity bonds anywhere.
Short-dated structures are cute, but don’t offer the relief that pension plans need.? So, I look at this market and do not expect much from it.? Credit risk and longevity risk are at odds with one another, and can be solved by the “magic man” who can earn returns superior to any excess longevity, or unsolved, leaving a larger problem in his wake, by the charlatan that delivers subpar returns.
That said, if you know the “magic man,” the pension fund should disintermediate and hire him.? Problem solved.? Now, where is this genius?
In this post, I want to talk about enhancing fixed income returns.? Next week, I will talk about hedging, or Tactical Asset Allocation.
My views on managing fixed income (bonds) are quirky.? I don?t look to maximize yield, as many do, but my view is to preserve the purchasing power of capital, which might lead to underperformance in the short-run.? There are times to grab yield, and times not to do so, and preserve capital.? Typically, the times to grab for yield are the times one would be scared to death to do so, like November 2008 and March 2009.
But to do that means being willing to take risk when everything seems to be dying.? Before I explain more, here is my stylized view of how the investment cycle works for equities and corporate bonds.? Gains and losses are not purely random, they tend to streak.? Here?s my stylized view of how an equity/credit cycle works:
After a washout, valuations are low and momentum is lousy.? People/Institutions are scared to death of equities and any instruments with credit exposure.? Only rebalancers and deep value players are buying here.? There might even be some sales from leveraged players forced by regulators, margin desks, or ?Risk control? desks.? Liquidity is at a premium.
But eventually momentum flattens, and yield spreads for the survivors begin to tighten.? Equities may have rallied some, but the move is widely disbelieved.? This is usually a good time to buy; even if you do get faked out, and momentum takes another leg down, valuation levels are pretty good, so the net isn?t far below you.
Slowly, but persistently the equity market rallies.? Momentum is strong.? The credit markets are quicker, with spreads tightening to normal-ish levels.? Bit-by-bit valuations rise until the markets are fairly valued.
Momentum remains strong.? Credit spreads are tight. Valuations are high, and most value-type players have reduced their exposures.? Liquidity is cheap, and only rebalancers are selling. ?(This is where we are now.)
The market continues to rise, but before the peak, momentum flattens, and the market meanders.? Credit spreads remain tight, but are edgy, and maybe a little volatile.? This is usually a good time to sell.? Remember, tops are often a process.
Cash flow proves insufficient to cover the debt at some institution or set of institutions, and defaults ensue.? Some think that the problem is an isolated one, but search begins for where there is additional weakness.? Credit spreads widen, momentum is lousy, and valuations fall to normal-ish levels.
The true size of the crisis is revealed, defaults mount, valuations are low, credit spreads are high.? A few institutions and investors fail who you wouldn?t have expected.? Momentum is lousy.? We are back to part 1 of the cycle.? Remember, bottoms are often an event.
You could call part 4 of my stylized cycle ?borrowed time.? But it is borrowed time that can last a long time.? At the end of the bull cycle, the equity market catches up to the credit market, creating a situation where the valuation of the equity can no longer be sustained by further increases in leverage (part 5 leading to part 6).
Now, value investors typically play the game from part 1 to part 4.? This is what drives the idea that value investors are always early.? Focusing solely on valuation, they arrive too soon, and leave too soon.
In 1994, I was part of a team that hired a clever small cap value manager to help manage money for our multiple manager funds.? The firm?s name was Moody, Aldrich & Sullivan; they were based in Boston.? One partner, Avery Aldrich, was their quantitative analyst, and he had a chart that I had never seen before: a two-dimensional grid for buy/hold/sell using valuation and momentum.? He said that it solved the problem of being early.? Using my seven parts, MA&S would take on the most exposure to risk in parts 2-5, when the most reward was received.
Applying this to Bonds
Here is the challenge: investment performance is a product of two main factors:
Valuation, a long run factor, and
Momentum, a short run factor.
These two factors interact with each other.? If momentum is positive, rising prices will make valuations rise, which lowers long-term return potential.? If momentum is negative, falling prices will make valuations fall, which raises long-term return potential.
In general, momentum changes more than valuation.? That?s to be expected.? When J.P. Morgan was asked by someone what the market would do that day, Morgan reportedly replied, ?It will fluctuate, young man. It will fluctuate.?
There are numerous articles, books, and posts that show that momentum tends to persist in the intermediate-term.? Here is one example from a study that I did, A Different Look at Industry Momentum ? II (and part one).? Mean-reversion can play a role over a 4-year period or so, but that seems to be a weaker effect.? Now momentum is not infallible, because when a lot of people follow it, the market goes nuts (1998-2000 for example) and then you get a wipeout.
But typically at times like that, valuations are high, so someone with an eye on valuation could avoid the wipeout as momentum flattens.
Now, with bonds, I have a model for valuation, but it is not simple.? I can analyze the relative risks of loss among different bond asset classes and compare that against spreads, and allocate to those that offer the best relative return.? I this environment, it means principal preservation is preferred to stretching for yield.
But what would a momentum model say?? I have a little more than 90 years of data on three yield series, the Aaa and Baa series on long corporate bonds from Moody?s, and Shiller?s long (usually 10-year) Treasury series.
Using a method that borrows from work done by Mebane Faber, I look at a ten month moving average of yields for each series, and invest in the one that has current yield lowest versus the moving average.? As yields fall, prices rise, and the bond subclass that has done best for the last ten months is likely to do better than most in the next month.
So, consider five strategies:
1.????? Invest and reinvest only in Treasuries.
2.????? Invest and reinvest only in Aaa corporate bonds.
3.????? Invest and reinvest only in Baa corporate bonds.
4.????? Invest in the one that has the yield the most below, or least above its 10-month moving average.
5.????? Invest and reinvest 36% in Treasuries, 19% in Aaa corporate, and 45% in Baa corporates.
Here are the results of those strategies over the last 91+ years:
Treasuries
Aaa
Baa
Switching
Weighted Average
Annualized Return
4.86%
5.94%
7.10%
6.58%
6.23%
Standard Deviation
9.02%
6.62%
8.12%
8.37%
6.04%
Now for a confession: when I first ran the analysis, the switching strategy had a return that was 1.5%/yr higher than what it shows now.? One simple math error did that.? Thus, I don?t have a worldbeater to trot out to you. At a later point I will revisit this, after thought, and not data abuse.
That said, the switching strategy isn?t bad, and seems to work well in high volatility environments.? But let me explain.
Buying and holding Baa corporate bonds (BBB for those speaking the language of S&P or Fitch) has always been the high returning option for corporate bonds.? After that comes Aaa, Aa, A, Ba, B, Caa.? For more on this look at Eric Falkenstein?s book Finding Alpha.? It is similar to what we know about the equity markets.? Those who take moderate risks do best.? After that, those who take little risk, then no risk, then a lot of risk.
You would think that Baa/BBB corporate bonds would be an asset of choice, but for most bond managers who have to compete against a broad benchmark, it would be too big of a bet to use them indiscriminately.? Some life insurers use them more aggressively, but it would be rare to go above 30%.
Now, relative to the standard deviation of returns the weighted average portfolio did well.? It mimics a AA- portfolio, which is pretty high quality.? The percentages came from the switching strategy.? Those percentages came from how often was the switching portfolio in Treasuries, Aaa, or Baa securities.
Lessons
Now, I only made one pass through the data.? I am not torturing the data to make it confess.? There might be better ways to do things.? But observing the momentum improves matters.? It is not as good as investing in Baa bonds, but who would run such a strategy?? If one is beating the Aaa bonds, it is good.
Another lesson is that investing for the average investment grade credit quality is good also.? The average mix is roughly Aa3/A1 (AA-/A+).? That would be similar to the main bond averages.
Lesson three is the pursing yield is rewarded, within limits.? If a society survives, and general order prevails, credit risk is generally rewarded.? It can?t be otherwise, aside from revolutions.
Lesson four is that switching yields better than its average, but the volatility is higher.? It kept up with Baa bonds for some time, but missed in the last cycle.? Had this analysis be run three years ago, the endorsement would have been strong for the switching strategy.? And that endorsement might be strong 10 years from now, because the strategy did well during periods of high volatility.
Caveats
1) Transaction costs would cut the fees of the switching strategy, but if ETFs and closed-end funds are used the effect can be minimized.
2) It?s easy to find Treasury funds, but hard to find Aaa and Baa corporate funds.? Most investment grade corporate funds are a blend of everything from Aaa to Baa.? This strategy as written will prove hard to implement.
But, maybe a variation might not prove so hard.? I plan on testing the difference between the current yield and the 10-month (or 200-day) moving average on a variety of ETFs, and seeing if it has any usefulness.
But the work for next week is writing up a trading model for stock indexes, and I have something more substantial to say there.
