The previous post explored the cyclic behaviour of the Fama French HML factor. I proposed further work to link HML to the economy. In fact, a literature search discovers that Liew and Vassilou (1999), document this effect:
The table contains past 12 month return of HML versus next year’s GDP growth.
The difference between ‘Bad States’ (GDP growth in bottom quartile) and other states is large in several countries. For example, in the US, average HML growth of 2.81% led to Bad States compared to about 10% ahead of other states.
This agrees with the time series plot in the previous post showing that extreme growth (low HML) typically leads to economic recessions.
Further to the last post I ran some ’4 year cycle’ analysis on pseudo factors.
Pseudo factors can be constructed by subtracting various Fama French portfolios:
‘High minus Up’ (Value minus Momentum) shows momentum outperforms value about 0.5% per month in the second half of the cycle, accelerating towards the end.
‘Up minus Market’ shows momentum outperforms the market at least 1% per month throughout the cycle. Note that exits from recessions favor value due to the ‘momentum crash’ phenomena documented by Daniel and Moskowitz.