An empirical examination of industry returns for evidence of cyclical performance : a thesis presented in partial fulfillment of the requirements for the degree Doctor of Philosophy at School of Economics and Finance, Massey University, Albany
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Date
2012
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Massey University
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Abstract
This dissertation provides three empirical studies of industry performance related to
different financial market cycles. Popular belief holds that industries provide systematic
cyclical performance. Such systematic performance would present a challenge to basic
assumptions of market efficiency. The three industry cycles investigated are sentiment
cycles, political cycles, and business cycles.
The first study investigates the interaction between three popular investor-sentiment
measures and industry performance. Investor sentiment has a widespread and systematic
effect on industry performance. Similar to prior market studies, investor sentiment
predicts short-term industry mispricing. Predictable long-term industry reversals are
weaker. Moreover, the effect of investor sentiment is widespread, with limited evidence
of cross-sectional industry differences. Unlike prior market studies, there is no evidence
of a relationship between investor sentiment and industry characteristics that serve as a
proxy for valuation uncertainty. Lastly, an industry rotation strategy based on investor
sentiment generates marginal outperformance, which turnover and transaction costs
would consume. Results generally show that investor sentiment has a market-wide
effect, questioning its usefulness in timing industry investments.
The second study examines industry returns for presidential election cycles. Risk adjusted
industry returns provide no evidence of political cycles previously documented
in the U.S. stock market. In spite of the existence of market-wide effects, realized
industry returns exhibit neither systematic nor persistent outperformance related to a
president’s political affiliation or the year of a president’s term. Expected industry
performance is equally unaffected by political cycles, exhibiting no systematic response
to presidential elections and indicating that the market does not systematically price a
president’s political affiliation in industry returns. The study’s results question the
popular belief that certain industries systematically perform better under Democrats or
Republicans and provide evidence that political cycles are solely a market-wide
phenomenon best explained at a macroeconomic level.
The third study investigates industry returns for systematic business-cycle
performance. Popular guidance holds that sectors/industries provide systematic
performance and that business-cycle rotation strategies generate excess market
performance. The study tests these two fundamental assumptions of popular rotation
strategies. Initially, the study assumes investors can perfectly anticipate business cycles
and implement conventional sector rotation. However, there is no evidence of
systematic sector performance where popular belief anticipates it will occur. At best,
conventional sector rotation generates 2.3 percent annual excess returns. This
performance quickly diminishes after an allowance for transaction costs and incorrectly
timing business cycles. An examination of all sectors across all business-cycle stages
produces evidence of in-sample systematic sector performance, but an out-of-sample
alternative rotation strategy fails to generate excess performance. Overall, the study
documents unsystematic sector performance across business cycles, questioning the
popularity of sector rotation as a viable investment strategy.
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Keywords
Industry performance, Cyclical performance, Market efficiency, Sentiment cycles, Political cycles, Business cycles, Stock price forecasting