Value vs. Earnings Yield
I hope those of you in the US enjoyed Thanksgiving weekend with your families while we took a brief hiatus from Factor Spotlight. This week, we'll provide an update on some factors we've been tracking for the past few weeks, as well as dig into an interesting phenomenon that we're observing in the relationship between Earnings Yield and Value.
In the days after our last note (11/16), the Market Intercept factor (99% correlated to the S&P 500) fell 3.29% until hitting a trough on 11/20, and has since staged a brief rally (now up 0.48%).
As a reminder, we've been following cumulative returns for Profitability, Market Sensitivity, and Volatility in an attempt to ascertain whether or not the market was starting to see a sustainable rebound. Here are updates on how those factors have moved on a cumulative basis over the past two weeks:
Volatility (11/16 - 11/29)
Market Sensitivity (11/16 - 11/29)
Profitability (11/16 - 11/29)
As we can observe, Market Sensitivity and Volatility have closely followed the path of the market - weakness heading into 11/20 giving way to a steady recovery. Meanwhile, Profitability saw some weakness and a chart that looks like the inverse of the other factors'. It's a little early to consider this a signal, and we'll continue to monitor these factors to see how they continue to trend.
Earnings Yield vs. Value
We've been watching an interesting trend unfold with regards to the two major valuation factors:
- Earnings Yield: measured as a combination of historical and forward Earnings/Price
- Value: measured as historical Book/Price
Depending on which of the two factors an investor chooses for their “value” exposure, they would have experienced completely different portfolio returns over the past three months (8/29/2018 - 11/29/2018):
How can two very similar metrics behave in almost opposite directions?
Let's examine the historical relationship of the factors across multiple market environments.
The chart below plots the trailing 1 year correlation between Earnings Yield & Value factor returns (BLUE) against the Russell 3000 index total return (RED). We have also highlighted the regions where the correlations have fallen sharply negative, which coincide with the Global Financial Crisis (2008-2009), market corrections related to the Sovereign Debt Crisis (2010 & 2012), and Factormaggedon (2015-2016).
As we can see, there historically appears to be a decoupling in the relationship between these two factors during periods of market turmoil. While we're currently isolating a few data points, we can't deny that we're seeing some interesting movement at the moment. In coming weeks, we'll do a deeper dive on these factors and follow how these trends play out over time.