Thursday, June 21, 2012

A Macro View: Michigan Inflation Expectations (17)

In one of my recent articles based on the ISM reports it used lagged linear regressions to derive at a group of stocks that should perform well in a variety of markets and especially well under rising ISM indexes (picking stocks based on the ISM Manufacturing Index with lagged indicators). This time I want to get back to exploring inflation based regressions in choosing stocks similar to the article using the PPI Index. Results from prior regressions on sector returns versus inflation indicators showed that the headline PPI had the highest degree of correlation.

But those regressions did not consider inflation expectations but just recorded levels of inflation backward looking. The University of Michigan Inflation Expectation (MICH) is one such index that takes a survey of consumers based on 1 year forward inflation expectations. Below is a graph of the MICH and CPI headline numbers and core CPI year over year for CPIs. While the MICH index shows to have a low correlation with CPI indicators, inflation expectations could exhibit a stronger predictor of stock movements as current prices are derived from the present state and also the expected state of being in the future. (Click to enlarge)

The first back-test (August 2000 to May 2012) used the 5 lag model as mentioned for the ISM reports. The results showed promise with over an 11% annualized rate of return and over 5% annualized differential return over the flat S&P index. This did mean higher volatility with bigger draw-downs and much bigger gains. But an expectation index is very unlikely to need to incorporate lags to capture delayed effects from events (changes in the index).

The second back-test (August 2000 to May 2012) (results below) used the basic Fama-French 3 factor model with the MICH index as the factor tested against. The results were an impressive 12.3% annualized return and 5.2% annualized return over the flat S&P 1500. The models sharpe ratio vs. S&P 1500 flat-weighted was at a healthy 0.46 and the simple Sharpe ratio was 0.32 during the back-test period. The mean monthly return was 1.29% vs. 0.91% for the S&P 1500 flat and median monthly return was 1.52% vs. 0.57% for the S&P 1500 flat. Stock picks below, divided by Sabrient's Strong Buy and Buy ratings, are based on results of the MICH index for April 2012 and rebalanced on June 13, 2012.
Strong Buys:
Deluxe Corporation (DLX)
Wyndham Worldwide Corporation (WYN)
Discover Financial Services (DFS)

Buys:
Concur Technologies, Inc. (CNQR)
Carpenter Technology Corporation (CRS)
Helix Energy Solutions Group, Inc. (HLX)
Snyder's-Lance, Inc. (LNCE)
Newfield Exploration Company (NFX)
Norfolk Southern Corporation (NSC)
Smithfield Foods, Inc. (SFD)
Safeway Inc. (SWY)
Universal Health Services, Inc., (UHS)
The Western Union Company (WU)
Health Management Associates, Inc. (HMA)
Humana Inc. (HUM)
Masco Corporation (MAS)
Myers Industries, Inc. (MYE)



Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
DFS STRONGBUY 32.83 LargeCap 99 63 79 98
DLX STRONGBUY 23.90 MidCap 64 65 28 65
WYN STRONGBUY 51.68 LargeCap 32 26 42 62


Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
CNQR BUY 67.75 MidCap 65 8 86 83
CRS BUY 43.90 MidCap 80 80 93 35
HLX BUY 15.28 MidCap 79 86 43 39
LNCE BUY 25.42 MidCap 43 34 46 65
NFX BUY 26.56 MidCap 52 89 65 24
NSC BUY 71.07 LargeCap 89 66 84 72
SFD BUY 20.67 MidCap 53 83 25 45
SWY BUY 17.64 MidCap 45 91 66 29
UHS BUY 39.79 MidCap 97 98 90 67
WU BUY 16.37 LargeCap 88 72 75 57

Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
HMA BUY 6.51 MidCap 64 89 55 49
HUM BUY 79.32 LargeCap 89 82 77 35
MAS BUY 13.83 MidCap 39 12 61 99
MYE BUY 16.78 SmallCap 68 31 71 83

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