19 Dec Buy Cheap
Buy Cheap
Post-election, companies that were cheap relative to their earnings (i.e., high earnings yield) have been among the top performers. Historically, companies with high earnings yield have not tended to outperform during periods of large price changes in the S&P 500. This has also been the case when inflation was increasing. However, the story is more nuanced when expectations of inflation are changing significantly.
Earnings Yield Performance
High earnings yield companies have performed well, pre- and post-election. Per Axioma, the earnings yield factor return has been among the top performing style factors since June 2016. This is consistent with the returns to a high earnings yield portfolio from the Kenneth French Data Library; trailing 12-month return has been trending up toward its long-term average for most of 2016.
Large Market Moves
Performance expectations for companies with high earnings yield depend on the lens. Relative to the S&P 500, performance tends to be negative for changes in the index greater than 10% (or a 2 event). A scatterplot comparing monthly returns for a high earnings yield portfolio with S&P 500 returns shows a slightly concave relationship.
A broader perspective of the equity market generates different results. A scatterplot comparing the same high earnings yield portfolio with a value-weighted index of all publicly-traded U.S. equity securities shows a positive relationship – positive (negative) returns when the index experiences large positive (negative) changes. Based on this data, the November outperformance for high earnings yield stocks was within expectations. On the other hand, if the recent equity market increase is short-lived, it appears that the portfolio is just as likely to reverse and underperform.
The Reflation Trade
There is little relationship between changes in inflation and the performance of high earnings yield companies. However, there is a modest relationship with changes in inflation expectations:
(1) A high earnings yield portfolio tends to outperform (underperform) for increases (decreases) in inflation expectations within a .5% rate change in the breakeven rate, which is 95% of the time.
(2) The portfolio tends to underperform when the breakeven rate increases or decreases more than .5%.
Returns and inflation were trending positive prior to the November election. As stated above, the earnings yield factor outperformed most style factors over the past 6-months and the Fama/French high earnings yield portfolio had been trending up. Inflation expectations, based on the 5-Year Breakeven Inflation Rate, had been trending positive during most of 2016. After the election, the change in expectations did not accelerate even though expectations continued to increase.
On balance, it is reasonable to attribute recent positive performance to the recent “reflation trade,” but it should be noted that the trends were in place before election day.
Notes:
(1) Timeframe: July, 1951 – October, 2016.
(2) High earnings yield portfolio is the equal-weighted portfolio of securities in the top 30% of U.S. equity securities ranked by earnings yield. Portfolio includes dividends. All data is from Kenneth French data library.
(3) Axioma data is as of 14 December 2016.