Can Predictable Patterns in Market Returns be Exploited Using Real Money?

Abstract

Academic studies suggest stock market prices are to a considerable extent predictable. Investors tend to earn higher returns when the market sells at relatively low price-earnings multiples and high dividend yields. Value stocks supposedly outperform growth stocks, and smaller companies produce higher returns than larger firms. Moreover, buying losers over the past several years supposedly trumps a strategy of buying recent winners. In fact, investment strategies undertaken with real money cannot make the excess returns that academic studies suggest. Market-timing strategies based on initial valuation metrics do not outperform a buy-and-hold strategy. Value stock, small-cap, and contrarian managers do not consistently outperform the market. The strongest statistical pattern we find among actual money managers is that returns are enhanced by low expenses and low turnover.