The Right Time to Buy High-Beta Stocks -- Journal Report
October 04 2020 - 9:06PM
Dow Jones News
By Mark Hulbert
A bedrock principle of investment theory is that, over time, the
high risk/reward shares known as high-beta stocks will make more
money than low-beta stocks. Now, new research suggests that
investors looking to take advantage of the potential of high-beta
stocks can best do so with an active trading strategy, rather than
simply holding high-beta stocks for the long term.
Beta refers to a stock's tendency to rise or fall along with the
broad market. If a stock has a beta greater than 1, for example, it
tends to rise more than averages like the S&P 500 when the
broad market rises -- and fall more when the market declines.
Low-beta stocks tend to rise or fall by less. Investment theory
holds that, in order to induce investors to incur high-beta stocks'
additional risk, they must over time produce a greater return.
But in practice, according to this new research, high-beta
stocks tend to outperform in just one week per quarter. Only in
that week, therefore, does it make sense that traders bet on
high-beta stocks over low-beta issues. In the other weeks of each
quarter, because high-beta stocks on average earn no greater return
than low-beta stocks, defensive approaches are the rational
bets.
This new research was conducted by Terry Marsh, an emeritus
finance professor at the University of California, Berkeley and
chief executive of Quantal International, a risk-management firm
for institutional investors, and Kam Fong Chan, a professor of
finance at the GBPUniversity of Western Australia. In an interview,
Prof. Marsh says the one week of the quarter in which high-beta
stocks are expected to beat low-beta stocks is the first really
busy week of the earnings season. For the current quarter, that is
the week of Oct. 19.
The earnings tell-all
The reason that the first week of earnings season plays this
outsize role, he adds: Investors in that week gain more insight
into the health of the economy than in all other weeks of the
quarter combined. In particular, we learn during that week how a
number of large-cap companies have done and are likely to perform
in subsequent quarters. Because these companies' operations are in
turn dependent on the health of so many different sectors and
industries, their earnings tell us a lot about how the overall
economy is really doing.
As examples of these companies whose operations shed such light
on the overall economy, Prof. Marsh mentions Goldman Sachs, United
Airlines, CSX and Netflix. All four of these companies' earnings
reports are scheduled for the week of Oct. 19.
Note that there is no guarantee that during the week of Oct. 19
in particular high-beta stocks will outperform low-beta stocks. It
could very well be, for example, that the story told by these five
companies will be that the economy is in worse shape than
previously thought. In that case, the market would most likely fall
and high-beta stocks would lose even more.
The professors' research instead applies to an average over
several years. Their prediction is that, over time, high-beta
stocks will outperform low-beta stocks in the first week of
earnings seasons.
Regardless of how high-beta stocks perform during the week of
Oct. 19, however, this new research is clear that there's no reason
to bet on them the other weeks of each quarter. That doesn't mean
you should automatically avoid high-beta stocks during those weeks.
It just means that you shouldn't bet on such stocks because of
their high beta. Absent a compelling reason to be in such high-beta
stocks, you should favor low-beta stocks if for no other reason
than you like to sleep more easily at night.
ETFs test the theory
Exchange-traded funds make it straightforward to put the
professors' theory into practice. One low-risk strategy for betting
on high beta over low beta during the first week of earnings season
would be to invest in a high-beta stock ETF while simultaneously
shorting an equal dollar amount of a low-beta ETF. During the other
weeks of the quarter you would do the reverse. An example of a
high-beta fund would be Invesco S&P 500 High Beta ETF (SPHB),
which invests in the 100 highest-beta stocks within the S&P
500. An example of a low-beta fund would be Invesco S&P 500 Low
VolatilityETF (SPLV), which invests in the 100 stocks within the
S&P 500 with the lowest volatility (which is closely related to
low beta).
Note that this would be a market-neutral strategy that would
make money regardless of whether the overall market is up or down
-- so long as low- and high-beta stocks produce the relative
returns that this new research forecasts. If you instead want to
follow the lead of this research while simultaneously betting on
the overall market, you could simply invest in the low-beta ETF for
all weeks except the first of earnings season, when you would
instead invest in the high-beta ETF.
Mr. Hulbert is a columnist whose Hulbert Ratings tracks
investment newsletters that pay a flat fee to be audited. He can be
reached at reports@wsj.com.
(END) Dow Jones Newswires
October 04, 2020 20:51 ET (00:51 GMT)
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