Entering text into the input field will update the search result below

Change Partners: Some Thoughts On Market Regimes

Jun. 02, 2020 12:32 AM ET8 Comments


  • Discusses two kinds of market regimes: those based on economic indicators and those based on stock factors.
  • Lays out the correlations between them.
  • Gives over fifty years of history of market regimes and their characteristics.
  • Concludes with a discussion of what market regime might come next.
  • I do much more than just articles at The Stock Evaluator: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

Two Kinds of “Market Regimes”

A lot of investors talk about “market regimes.”

This term can have several different meanings. Classically, a market regime is characterized primarily by four measures: interest rates, inflation, GDP growth, and unemployment; often added to these are characterizations of government fiscal and monetary policy. But one can also talk about a market regime in terms of which stock factors work and which don’t.

For example, in terms of the economy, the last five years was a period characterized by low interest rates, low inflation, low GDP growth, and low unemployment (this last item has just changed dramatically). In terms of the stock market, the period can be characterized by large caps outperforming small caps, expensive stocks outperforming cheap stocks, momentum outperforming reversion, and low volatility outperforming high volatility.

There was, in fact, another period in which all this was true: 2007. And then there have been periods in which the reverse of all these was the case: in 1991, for instance, inflation, interest rates, and unemployment were all high (though GDP growth wasn’t), small caps and cheap stocks did well, and momentum and low-volatility strategies underperformed, while the same could be said of 1982 except for the momentum part.

Many investors have devoted a lot of energy into identifying what market regime is coming next—or what market regime we’re currently in—and allocating their assets accordingly. But to what extent do the various components of a “market regime” actually go together? If we were to characterize time periods based on these four economic indicators and these four stock factors would we find any consistency?

I decided to test this looking at stock returns from the last 57 years, from 1963 to today, relying on Kenneth French’s library for factor returns and on Federal Reserve Economic

My marketplace service, The Stock Evaluator, comprehensively ranks close to 5,000 stocks weekly based on a sophisticated multi-factor system with deep roots in accounting and valuation methods. It has a terrific out-of-sample record: over the two years since the service began, high-ranked stocks have consistently outperformed the market while low-ranked stocks have massively underperformed it.

This article was written by

Yuval Taylor profile picture

Yuval Taylor is an author and analyst with 8 years of experience using multifactor ranking systems to buy and sell stocks. He focuses on microcaps and emphasizes evaluating every stock from as many angles as possible via algorithm. He is the leader of the investing group The Stock Evaluator.

Features of the service include: disclosure of Yuval’s personal positions, 2 unique portfolios, a spreadsheet of nearly 10,000 stocks rated from 0 to 100 weekly, and live chat for questions. Learn more.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Recommended For You

Comments (8)

Ryan Telford profile picture
Another fantastic article Yuval, thanks.

I've wrestled with the regime change question for a while, but have come to the conclusion that instead of "timing" the change, you can still come out ahead if you take positions based on tracking short term performance of different factors and adjusting your system accordingly.

This is also a mindset shift, as a quant I've been conditioned to look at backtests over long periods of time. I do believe, however, there is much value in looking at short term performance and being flexible to suit the market's sentiment.
Yuval Taylor profile picture
I agree, Ryan. Striking the right balance between short-term and long-term factor performance is a tricky business, but is probably the best approach.
Ray Meadows, CFA profile picture
A very interesting article. I appreciate your work in laying out the correlations and your interpretations. But I can provide alternative interpretations on a few which lead to different conclusions about the future.
In my view inflation is correlated with interest rates because the Federal Reserve has historically raised rates when inflation was rising. For a number of socio-economic reasons, I don't think that will happen this time.
I also believe that the reason you find inflation and real GDP negatively correlated is that big moves up in inflation correspond with disruption of the price signals driving allocations in the economy and the adjustment process adversely impacts real growth.
The original Philips curve paper used data from a period where the currency was linked to gold and thus we could interpret it as finding a relationship between the real price of labor and the amount demanded as we would expect in any market economy. The idea that the market could be fooled into mistaking inflation for change in real wages and thus effecting employment came later.
I mention these things because I agree that the economic regime will likely shift over the next few years to one where inflation is rising yet interest rates remain low. The question then is: what are the appropriate investments for the new environment?
Yuval Taylor profile picture
Ray, I think your logic about the reason for these correlations is better than mine. And your question--what are the appropriate investments for an environment characterized by rising inflation and low interest rates--is a good one. History gives us few, if any, clues.
Marc Gerstein profile picture
As the person quoted toward the end of the article, I need to point out that it was a few months ago, and that given the pace at which the world has been moving, a few months is a long time. While I still adhere to much of what I said back then, it does look like the onset of re-inflation is being pushed back -- at least as thing appear now.

The bigger issue though is the treatment of the topic of regimes. The perspective is way way way too narrow and that may ave something to do with the author's statement that he lacks my "confidence, conviction, and insight."

Regimes are not about factor, indicators or whatever. They are about the characteristics of the real (non mathematical) world that cause the factors and indicators to behave as they do. They are about history, politics, society, culture, etc. Unless you understand what's happening in these terms and recognize how they influence markets, you have no hope whatsoever of understanding market "regimes." Although "quants" like to play around with regimes, that doesn't mean their work is worthwhile or even prudent. I once tried to check out this angle but abandoned it when I quickly saw that the entire task -- quantification of regimes -- was nonsense. Children like to play with fire but sometimes, one has to be taught that one should be careful playing with things that can hurt them if misused.

If you want to understand regimes, close your spreadsheets, turn off your computer, and study up on socio-political-economic history of the last 150-or-so years. Notice the ebb and flow of the interaction between the different strata of society and work to identify where we've been recently, where we are now, and where we seem to be headed. Factor in today's Black Lives Matter protests, which now are playing a role similar to what the Civil Rights/anti Vietnam War protests played some decades ago and how this pushes regime shift.
Yuval Taylor profile picture
I like the idea that regimes are unquantifiable and must be considered only holistically, as a result of the interactions between politics, society, and economics. I also agree that only deep study of history can qualify one to characterize any particular regime, and that such a characterization is better done in "literary" terms than through data. I'm glad you expressed this here, Marc; it's a valuable corrective to a purely data-based approach. One of the reasons I wrote this article was that I was struck by the improbability of a data-based approach to regime change yielding any actionable results; your comments confirm my doubts.
Very high value article for me. Thanks.
I was unable to read graphs two and three.

Just wondering if the number of listed companies having decreased in recent years has influenced stock prices.

From the internet:
"The number of public companies in the U.S. has been on a steady decline since peaking in the late 1990s. In 1996 there were 7,322 domestic companies listed on U.S. stock exchanges. Today there are only 3,671.Nov 16, 2017"

Disagree with this article? Submit your own. To report a factual error in this article, . Your feedback matters to us!

Related Analysis

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.