Signal2Noise (S2N) News
Posts
#254: Its a Matter of Factor

#254: Its a Matter of Factor

Michael Berman, Ph.D.
March 18, 2025

Try my new dashboard; it helps identify larger than normal daily moves in real-time.

S2N Spotlight

You often hear of factor investing. I have never really delved too deeply into this area, but the topic keeps popping up in my research, so I thought I would explore a little. I came across it many years ago when Nobel Prize Winner Eugene Fama, together with Kenneth French, put it on the map.

Factors are character traits that explain performance. Let me give you a few examples: momentum, value, quality, small, etc. What Fama-French discovered was that by isolating certain factors and investing over a long time horizon, those character traits would lead to outperformance in probabilistic terms.

Very, very important factors do not predict the market. At best, you could say that factor investing weakens the Efficient Market Hypothesis (EMH), for which Fama won his Nobel Prize. I love how these 2 discoveries create a tension with one another but do not negate each other. Sometimes lifes deepest insights are discovered within conflict.

It is maybe easier to understand with an example. Imagine two stocks:

One is a cheap, small-cap, high-profit company (Value + Size + Quality)
The other is a large, expensive, low-profit tech stock

According to factor investing, investors who invest in cheap, small, quality stocks compared to large, expensive, low-quality stocks will do better over time.

I have produced a 10-year chart of cumulative returns and 1-year returns. Momentum investing has produced the best 10-year returns, with value and small caps producing the worst long-term returns. Low volatility has produced the best 1-year returns, which is not all that surprising given the volatility of late.

We will come back to this subject in the near future, as I think there is more to learn.

S2N Observations

Gold’s spot price ended the day above 3000 for a closing ATH. Adding to yesterday’s theme on gold miners, there is an index on the NYSE called the gold bug index, ticker HUI, which focuses on the main gold miners who have not hedged their gold for more than 1.5 years. This is highly correlated with the gold miner etf GDX. What I found interesting is that the index is still trading below its July 2020 high. Clearly, a lot of central banks have been buying gold directly and ignoring the miners. Perhaps this is a golden opportunity for miners to play catchup.

A week or so ago, I made a strong case for high-yielding junk spreads to rise. This is exactly what has happened along with volatility in the bond index (MOVE).

The purest way to trade this idea was to go long TLT (quality long-term bonds) and short JNK. I am sharing a chart of the Junk Bond ETF, which is looking like it wants to trade lower. See ya in the yard.