Robert R. Johnson

Business conditions, monetary policy, and expected security returns

Abstract We examine the evidence that expected security returns can be forecasted by the term premium, default premium, and dividend yield, in light of recent findings that similar security return patterns are associated with Federal Reserve monetary policy developments. We extend Fama and Frenchs (1989) analysis by suggesting that the monetary environment influences investors required returns, and hence the robustness of the models they propose. Our findings indicate that Fama and Frenchs results vary dramatically across monetary environments; that is, the behavior of the business-conditions proxies and their influence on expected security returns is significantly affected by the monetary sector.

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.

Asian Economic Integration and Stock Market Comovement

Using daily returns from 1988 to 1998, we investigate to what degree twelve equity markets in Asia are integrated with Japans equity market and examine the factors that affect the level of economic integration. We find that the equity markets of Australia, China, Hong Kong, Malaysia, New Zealand, and Singapore are highly integrated with the stock market in Japan. There is also evidence that these Asian markets become more integrated over time, especially since 1994. A higher import share as well as a greater differential in inflation rates, real interest rates, and gross domestic product growth rates have negative effects on stock market comovements between country pairs. Conversely, increased export share by Asian economies to Japan and greater foreign direct investment from Japan to other Asian economies contribute to greater comovement. Southern Finance Association and the Southwestern Finance Association.

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.

Economic integration and stock market comovement in the Americas

Abstract Using daily returns from 1988 through 1999 for Argentina, Brazil, Chile, Mexico, and Canada, and from 1993 to 1999 for Colombia, Peru and Venezuela, we investigate to what degree these equity markets are integrated with the US equity market and examine the factors that affect the level of economic integration. We find a statistically significant high percentage of contemporaneous association between the eight equity markets of the Americas and the stock market in the United States. A high share of trade with the United States has a strong positive effect on stock market comovements. Conversely, increased bilateral exchange rate volatility and a higher ratio of stock market capitalization relative to that of the United States contribute to lower comovement.

Indicators of Successful Companies

Using monthly Compustat data for 478 companies covering the period 1982-1998, we investigate which factors discriminate between financially successful and less successful companies. Financial success is measured using three different methods, i.e., the Sharpe ratio, Jensens alpha, and EVA. We consider a total of 10 different company specific characteristics as potential indicators of superior performance. A binary logit model is applied to quantify the relationship between the individual firm characteristics and the probability that a particular measure of success will be greater or lower than the average for all firms considered. We also calculate the percentage correct prediction by the model for each measure of success. We find that especially large profitable firms with efficient working capital management and a certain degree of uniqueness regarding their business are the most successful companies.

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.

The Association Between Executive Stock Option Plan Changes and Managerial Decision Making

This paper examines the behavior of managerial investment, dividend, and capital structure decisions subsequent to the adoption of stock options as part of the compensation package. Previous studies have documented a positive stock market reaction to changes in incentive compensation plans. The specific changes that such plans induce remain unclear. Surprisingly, firms that increase incentive stock option plans experience earnings declines, on average, relative to their industries. A decline in expenditures on R&D and an increase in selling, general and administrative expenses is also documented.