Mark Hooker, Ph.D, of Advanced Research Center recently released a study in which he looked at the returns from value and momentum during low/medium/high inflationary episodes in the US back to the 1920s.
After many years of being a minor concern for US investors, inflation worries have again assumed a more prominent position in the investment landscape. While core inflation has remained muted, headline figures have been whipsawed by dramatic movements in energy prices, and the outlook has been clouded by countervailing pressures from the deep recession on the one hand and the government’s massive stimulus measures and the resulting extraordinarily high deficits on the other hand. These forces threaten to trigger a shift from the benign inflation regime enjoyed over the past roughly 25 years in the U.S. to something more like the volatile earlier experience shown in Chart 1.
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Dr. Hooker used the data library compiled and made available by Professor Ken French. It contains returns on US stocks grouped into deciles by several factors that are relevant for bottom-up quantitative stock selection models back to the 1920s. He used book-to-price ratio as his value metric, and he used trailing 12-month total return for his momentum metric.
In our analysis, we evaluate the performance of a value-only, a momentum-only, and a 50/50 value/momentum model, in each case as represented by returns on the top-ranked decile (10%) of stocks relative to the bottom decile.
The results of the study are found in the tables below:
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The study concludes that value does better during low or falling inflation while momentum does much better during rising and high inflation. Again, we see the merit of combining value and momentum strategies. Furthermore, in light of the surge in money supply (15% year-over-year growth in the M1 money supply) that we have seen in recent years, and economic recovery that is well on its way, I think it is reasonable to expect that inflation will be on the rise in coming years. Momentum (relative strength) strategies may well be increasingly valuable in the years ahead.
HT: World Beta
