Is it Time for a Recessionary Investment Factor Tilt?

I have featured Research Affiliates articles before and I have discussed factor based investing tilts before. It would seem we are on the cusp of a shift in the underlying economy into a recessionary or at least slow growth phase. What type of stocks historically add value in this part of the cycle? In recent weeks I’ve been suggesting that it’s time to make your portfolios a little more boring. All should be familiar with the 4 stages of the business cycle. There has been a lot of debate about a stagflationary slowdown or possible recession given the inverted yield curve. If this is where we are heading, it would be helpful to know what market factors can help you weather the storm.

• Slowdown: non-recessionary below-trend growth
• Recession: two consecutive quarters of negative growth
• Recovery: post-recessionary (24 months) above-trend growth
• Growth: remaining months (after the first 24) of above-trend growth

In summarizing the results, Research Affiliates (RA) analyzed the relationship across six geographic regions and over all four economic stages of growth, slowdown, recession, and recovery to discover the historical nature of that relationship. The majority of the eight factors (including the market factor which is the return above risk-free) that they examined produced a positive and significant total return over the full study period. Three components drive the total return: changes in fundamentals, changes in valuation, and valuation rebalancing. One could argue today, the equity markets still close to all time highs, have yet to adjust, though many would agree that the worst start to the year in decades for the traditional 60:40 portfolio suggests that it’s likely underway.

Fewer factors produced meaningful returns when considering a factor’s structural return, the portion of the return that is indefinitely repeatable. Over the study period, the value factor has the highest structural return. The higher economically leveraged (cyclical) factors—market, size, value, and illiquidity—perform better during the positive economic stages of recovery and growth, and perform poorly during the negative economic stages of recessions and slowdowns. The opposite applies to the less economically leveraged factors—low beta and profitability.

The table summarizes results. Let’s focus on the low beta and profitability factors.

Scanning the ETF world, we came across some high dividend (typically means good profitability) and low volatility ETFs. We compared returns since 12/31/19 (pre-covid) against the broad US market returns (VTI – Vanguard total US market ETF). Clearly the broad market won with a higher average return.

But on a YTD basis, the higher dividend and lower beta ETFs have done much better than the broader markets as we are starting to price in a more difficult economic outcome.

The first ETFs focusing on the profitability factor were only launched a few months ago. Dimensional Advisors, a factor based asset manager, launched a US and International profitability factor ETF in February. So far, it’s looking a lot like the market return, but we should keep a close eye on this one.

Like we have in recent weeks, this week on our Spring 2022 virtual Berman’s Call roadshow, we will take a deep dive on how to incorporate investment factor thinking in to your portfolios. Join us weekly (Thursday 7pm ET) through April 28th. Keep an eye on The Investor’s Guide to Thriving website for more information on how to sign up for notifications. The theme this year is Berman’s Call deep dives. More in-depth looks on combining fundamentals and technicals to mine for investment ideas. Should be a great series. If you have learned a few things over the years from our educational segments, please consider supporting one of my favourite charities. Dementia and Alzheimer’s research at the Baycrest Hospital/Rotman Research Institute is world class. Each year I raise money for this cause and match all BNN viewer donations. In the past 9 years we have raised almost $500,000 thanks to you. Please consider sponsoring here.

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