Gerald R. Jensen

Efficient use of commodity futures in diversified portfolios

We provide evidence on the role of commodity futures in portfolios comprised of stocks, bonds, T‐bills, and real estate. Over the period investigated (1973–1997), Markowitz optimization over a range of risk levels gives substantial weight to commodity futures, thereby enhancing the portfolios’ returns. We find dramatically different results when we use a simple ex ante measure of monetary stringency to dichotomize the sample into expansive‐versus‐restrictive monetary‐policy periods. In periods characterized by restrictive monetary policy, commodity futures are shown to have substantial weight in the efficient portfolios, with significant return enhancement at all levels of risk. In periods characterized by expansive monetary policy, commodity futures are shown to have little or no weight in the efficient portfolios, with no return enhancement at all levels of risk.

Monetary environments and international stock returns

Abstract Previous research documents that US stock returns are related to the US monetary environment. The focus of this paper is to determine whether stock returns in foreign markets are associated with both local and US monetary environments. Consistent with the US market results, we find that foreign stock returns are generally higher in expansive US and local monetary environments than they are in restrictive environments. Further, these higher returns are generally not accompanied by increases in risk. Interestingly, several of the stock markets are more strongly related to the US monetary environment than to local monetary conditions. For seven of the 15 foreign countries examined, the local and US monetary environment explain 4% or more of the variation in monthly stock returns.

Discount rate changes and security returns in the U.S., 1962–1991

Abstract It is well-known that financial markets respond quickly to announcements of changes in the discount rate. We extend previous research and ask whether rate changes provide information about subsequent long-term market performance. Between 1962 and 1991, stock returns following discount rate decreases are higher and less volatile than returns following rate increases. The stock performance patterns are not due to changes in short or long-term bond rates.

Tactical Asset Allocation and Commodity Futures

In this article the authors examine the diversification benefits of adding managed and unmanaged commodity futures to a traditional portfolio that consists of U.S. equities, foreign equities, corporate bonds, and Treasury bills from 1973 through 1999. Consistent with previous evidence, they find that commodity futures substantially enhance portfolio performance for investors, and managed futures provide the greatest benefit. They show that the benefits of adding commodity futures (both managed and unmanaged) accrue almost exclusively when the Federal Reserve is following a restrictive monetary policy. The results suggest that metals and agricultural futures contracts offer the most diversification benefits for investors. Overall, the findings indicate that investors should gauge monetary conditions to determine the optimal allocation of commodity futures within a portfolio, and whether a short or a long position should be established in a particular type of contract.

Presidential Politics, Stocks, Bonds, Bills, and Inflation

Several studies show no significant difference in stock market performance between Republican and Democratic presidential administrations. While the authors confirm this finding for an index of large-capitalization stocks, they find that small-capitalization stocks perform Insignificantly better during Democratic administrations (an annual return difference of over 20%). The authors also present new evidence that the debt market performs significantly better during Republican administrations. In fact, on average, they find that real returns to debt during the 1929 through 1996 period have been negative.

Monetary Policy and the Cross‐Section of Expected Stock Returns

Ample evidence shows that size and book-to-market equity explain significant cross-sectional variation in stock returns, whereas beta explains little or none of the variation. Recent studies also demonstrate that proxies for monetary stringency increase the explained variation in stock returns. We reexamine a three-factor model that includes beta, size, and book-to-market equity, while allowing monetary conditions to influence the relations between these risk factors and average stock returns. We find that ex-ante proxies for monetary stringency significantly influence the relations between stock returns and all three risk factors. Additionally, all three variables are found to contribute significantly to explaining cross-sectional returns in a three-factor model that includes the monetary sector. Southern Finance Association and the Southwestern Finance Association.

Can Precious Metals Make Your Portfolio Shine

We extend earlier studies and present new evidence on the benefits of adding precious metals to U.S. equity portfolios. We report five major findings related to the potential benefits of investing in precious metals either directly via the commodity or indirectly via equities. First, we find that adding a 25% allocation to the equities of precious metals firms improves portfolio performance substantially. Second, our evidence indicates that an indirect investment dominates a direct investment in precious metals. Third, relative to platinum and silver, gold has better stand-alone performance and appears to provide a better hedge against the negative effects of inflationary pressures. Fourth, the benefits of precious metals are strongly tied to monetary conditions. Finally, while the benefits of adding precious metals to an investment portfolio varied somewhat over time, they prevailed throughout much of the 34-year period. Overall, our evidence suggests that investors could improve portfolio performance considerably by adding a significant exposure to the equities of precious metals firms.

The Dynamics of Corporate Dividend Reductions

The claim that divided payments serve as signals to market participants is widely accepted. However, recent evidence has increased the uncertainty regarding the information conveyed when a firm drops its dividend. In particular, DeAngelo, DeAngelo, and Skinner (1992) and Healy and Palepu (1988) find that a dividend reduction tends to be followed by a significant increase in firm earnings. Our analysis extends prior research by examining twenty-one firm characteristics three years before and three years after a dividend drop. Consistent with past results, we find that firm earnings drop prior to a dividend reduction and increase afterwards. However, following a dividend drop, firms tend to reduce asset expenditures, external financing activities, employees, and spending on R&D. In addition, firms tend to sell more assets and their sales level remains depressed in the post-dividend-drop period. These post-dividend-drop occurrences may negatively impact a firms future competitive position and, furthermore, may explain the negative stock price reaction that accompanies the dividend-drop announcement. Overall, our results suggest that a dividend-drop marks the end of a firms financial decline and the beginning of firm restructuring.

Is Now the Time to Add Commodities to Your Portfolio

With the recent increase in equity volatility, commodity investments have garnered significant attention from investors. Previous research has found substantial benefits associated with commodity investments, but there remains considerable uncertainty regarding the consistency and general applicability of those benefits for equity investors. This article provides evidence that helps to resolve some of the uncertainty with regard to commodity investments. Specifically, based on a sample period of 36 years, it shows substantial benefits to commodity investments regardless of the equity style an investor pursues. Obtaining a significant benefit, however, requires a commodity allocation greater than 5%. Interestingly, adding a commodity exposure enhances an equity portfolio’s return only during periods when the Federal Reserve is increasing interest rates, which is consistent with the belief that a major attraction of commodities is that they serve as an inflation hedge. Furthermore, an allocation to commodities in a tactical asset allocation using monetary conditions consistently outperforms both a strategic commodities allocation and an all-equity portfolio.

Is Fed Policy Still Relevant for Investors

Thirty-eight years of U.S. data indicate that U.S. monetary policy continues to have a strong relationship with security returns. U.S. stock returns are consistently higher and less volatile when the Federal Reserve is following an expansive monetary policy. Furthermore, the monetary policy–related return patterns of companies considered to be most sensitive to changes in monetary conditions are much more pronounced than average patterns. Finally, the influence of U.S. monetary policy is global; international indexes have return patterns similar to those for the U.S. market. Overall, the evidence suggests that investment professionals should continue to consider monetary conditions when performing fundamental analysis of U.S. and international securities. Numerous studies have documented the relationship between monetary policy and security returns, but the relevance of monetary conditions in investment analysis is still debated. In particular, questions have been raised about the continued importance of U.S. monetary policy in recent periods. To study this issue, we analyzed stock returns following changes in the U.S. Federal Reserve’s monetary policy in 21 separate monetary policy environments that occurred from the middle of July 1963 to early 2001. We considered U.S. stocks in general, U.S. stocks grouped according to size and along the value–growth dimension, U.S. stocks by industrial sector, and international stocks. We identified a change in Fed monetary policy as a directional change in the Fed discount rate. We used daily returns (rather than monthly returns) to provide an accurate assessment of returns. To the cross-sectional study, we added an exploration of the time-series consistency of all the relationships. Our findings support the following claims: First, monetary conditions have had and continue to have a strong relationship with security returns. In particular, periods of expansive monetary policy are associated with strong stock performance (higher-than-average returns and lower-than-average risk), whereas periods of restrictive monetary policy generally coincide with weak stock performance (lower-than-average returns and higher-than-average risk). Second, a highly consistent relationship between monetary conditions and stock returns is evident over time. Although initial analysis suggests the relationship has diminished, a more thorough investigation indicates that a single monetary period that occurred in the mid-1990s is largely responsible for this conclusion. Third, small-cap companies are more sensitive than large-cap companies to changes in monetary conditions. Portfolios of small-cap stocks have economically and statistically significant monetary policy–related return patterns that are consistent over time. Fourth, cyclical stocks have a much higher sensitivity to changes in monetary conditions than defensive stocks. For example, stocks in the cyclical consumer goods, cyclical financial services, and information technology sectors had expansive-period returns that were more than 26 percentage points a year higher than the returns they earned during restrictive periods. Finally, U.S. monetary policy has an important influence on global markets. We found significant return patterns related to U.S. monetary policy for five international stock indexes. This evidence is consistent with the prominent role U.S. economic conditions play in the prospects of foreign companies. Overall, our evidence strongly suggests that practitioners should devote considerable attention to monetary conditions as part of a thorough economic analysis. Furthermore, because sensitivity to changes in monetary conditions deviates considerably among sectors, a rigorous industry analysis is also essential. Finally, investment professionals who are attempting a sector or industry rotation strategy should carefully monitor changes in Fed monetary policy.