Predicting Anomalies with politics, weather, global warming, sunspots, and the stars

Predicting Anomalies with politics, weather, global warming, sunspots, and the stars

February 25, 2016 Academic Research Recap, Architect Academic Insights
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We’ve discussed the use of predictive regressions in the past. Here is an article to learn a bit more about the technique.

And while the idea sounds cool, and could even be relabeled a low-tier “machine-learning” technique if someone wanted to sell the idea, we can’t find anything exciting about the technique. Our mea culpa on trying to time the market is outlined in the first few paragraphs of our fairly detailed post on our downside protection system.

Having your cake and eating it too is a great way to go. It’s great to have the cake, and it’s also great to eat the cake. But you can’t have it both ways. This trend continues when we speak with fellow investors: “Give me high, after-tax, net of fee returns, but with limited risk and volatility.” Now, we certainly love high returns with low risk. We also love high reward with low effort and high calories with low weight gain. Unfortunately, this brings us to our first problem with the investing unicorn: Unicorns don’t exist, and neither do high returns with low risk. 

Novy-Marx has a fun paper — with a great title — that emphasize the futility of using predictive regression techniques to try and time the performance of various anomalies.  We actually highlighted this paper over 4 years ago, but here is the published edition.

Predicting anomaly performance with politics, the weather, global warming, sunspots, and the stars

Predictive regressions find that the party of the US president, the weather in Manhattan, global warming, the El Niño phenomenon, sunspots, and the conjunctions of the planets all have significant power predicting the performance of popular anomalies. The interpretation of these results has important implications for the asset pricing literature.

Here is a great table from the paper:

sunspots
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Doing research can be incredibly humbling. Especially when someone highlights that we’re probably all full of bunk!

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.