Strategy Preference Can Indicate Expected Stock Market Returns

By C. Thomas Howard, PhD via

Active equity strategies provide a tool for estimating expected stock market returns.

The framework for organizing active equity strategies can help provide an estimate of current expected stock market returns. This is accomplished by measuring the recent investor response to each strategy, which, it turns out, captures the deep behavioral currents driving market returns. The resulting information is useful when managing equity market exposure.

Investment strategies were first introduced in this series as an alternative to the Style Grid for forming active equity mutual fund peer groups. Follow-up articles discussed the advantage of diversifying equity portfolios based on fund strategy, how to identify the best funds within each strategy, when stock picking works best, and how fund managers overweight their best-idea stocks. We close the series examining the power of strategies for estimating expected market returns.

Market Factors and the Strategy Market Barometer

As we know, aggregate stock market returns are driven by the collective buy and sell decisions of individual and institutional investors. Many market factors enter into their decisions, and the relative importance of each factor evolves over time. At times, investors place more importance on economy-wide data, stock market activity or specific industry sectors or stocks.

When estimating overall market expected returns, it is important to know the current mix of factors favored by investors.

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