January 2023 Update

Quantitative Stock Rating Model: Performance and Discussion

Our quantitative stock rating model, launched at the beginning of 2022, uses composite factors across five dimensions (value, quality, momentum, estimates, and investment) to predict individual stock performance. The stock rating model produces a list of 100 favored investments from across the S&P 500.

After turning in a fantastic November, the model continued to pick winners in December, as its basket of favored stocks outperformed the S&P 500 index by 1.5%. For 2022, the favored basket outperformed the S&P 500 by 9.3%. Fig. 1 shows the performance of the basket of favored stocks and the S&P 500 by year, starting in 2001.

Fig. 2 shows the performance for each of the 5 composite factors that make up the stock rating model (dark blue bars), along with the performance of the overall model (light blue bar at right) during December. Of the five composite factors, four outperformed the overall index. The momentum and estimate composites each contributed 1.6% of relative outperformance.

Market Valuation: Residual Income Model

We use a residual income model to value the market[1]. The residual income model produces an estimate for the equity risk premium, or the additional return that equity investors are compensated over the risk-free rate.

Using the equity risk premium, we can evaluate the relative attractiveness of equities compared to investment grade fixed income via the ratio of their yields (see Fig. 3). Historically, when equities are expensive compared to fixed income (i.e., equities have a relatively low yield) the stock market experiences smaller average returns and higher volatility. The latest reading for the yield ratio indicates that equities remain overvalued relative to investment grade fixed income. As a result, we expect muted returns and higher volatility for the equity market over the next 3 months.

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[1] See https://fundstrat.com/wp-content/uploads/2021/12/20211221_Quant_Strategy.pdf