The Fama-French value factor HML exhibits a fairly reliable 4 year cycle. Growth and Value out-performance oscillates with a 4 year period (see my previous post on this).
Where are we in the current cycle?
The black line is the 12 month moving average of HML. St. Louis Fed recessions are in red. HML lows clearly occur in years divisible by 4, although can lead or lag by a few months. Lows correspond to high growth, which often (but not always) leads to recession. One hypothesis is that the recession corrects the growth excesses in overheated parts of the economy.
HML is currently at or near the cycle low (circled). Therefore conditions are in place for a potential recession. Also of note is how rapidly value outperforms growth on recession exits.
Fortunately there are better recession forecasting tools than HML because the majority of market periods of extended weakness are coincident with recession. The chart below shows the 12 month average of the Market Factor in black.
This highlights why using the sign of the 12 month return as an investment filter is so effective. Once the return turns negative, the downturn is generally sustained.
However, the 12 month return may not provide an optimum re-entry signal. Various oversold measures such as percentage of stocks below an N day moving average could be compared to typical recession levels to scale into value funds at low prices.
As the 12 month rolling return becomes increasingly negative, forward average annual returns rapidly rise: