Quest For The Holy Grail: The Fair Value Of The Equity Market
March 27, 2017
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By building off AIM’s benchmark we are setting the bar relatively high for contrarian investing. First, we rebalance monthly, which tends to skew the performance toward strategies such as momentum rather than value. Second, the investment decision used in our portfolio test ignores the actual yield on cash, the other investment opportunity. Indeed, on several past occasions, stocks, even though expensive, still provided a more attractive expected return than cash, whose return is controlled by the Federal Reserve. We believe, however, that by setting a high bar for our portfolio test, we can offer more transparent and compelling evidence.
The equity allocations that result for both historical contrarian and macro-vol contrarian strategies are nearly identical in the early years of our analysis. After the early 1950s, however, as the level of macroeconomic volatility starts to fall, the holdings of the macro-vol contrarian strategy begin to deviate from those of the historical contrarian strategy. We observe that significant changes in macroeconomic volatility are reflected in the allocations of the risk-conditional strategy as it gradually reacts to the changing environment, resulting in larger relative allocations to equities.