New Research Sheds Light On Key Historic Stock Market Drivers

There’s a lot of research slicing and dicing stock market returns. However, most are analyzing the same data covering from 1960s to today. That’s why recent research on pre-1926 market history is enlightening.

A new study is novel in examining an earlier period (1866-1926) than most researchers assess. It provides another six decades of relatively new data on almost total 1,500 stocks, with roughly individual 200 stocks in each of the individual decades.

Out Of Sample Testing

This helps with out of sample testing. That’s helpful because with today’s levels of computing power, data can easily be manipulated. With today’s technology, it can be easy to find relationships that appear statistically impressive, yet lack predictive meaning.

Looking outside of the original period can be one good way to validate or contradict a theory. The research is conducted by researchers at Robeco Quantitative Investments and titled The Cross Section of Stock Market Returns before 1926 (And Beyond).

Factor Analysis

So looking at this new data set, what do we find? Many of the more robust relationships that we seen in the typical more modern data set do hold up historically, though the strength of the factors do change.

Value

A value-oriented approach has historically helped investment returns over time, on average. That holds up in this earlier period too. Here that analysis is done based on dividend yields, showing that stocks with higher dividends perform better over time than the broader market. In fact, this effect is stronger than in more recent periods. Other factors hold up too.

Momentum

Momentum, which is the concept that stocks that have risen in price over recent months, continue to see better than average stock performance over subsequent months. However, the momentum effect appears smaller in this earlier period than with more recent data.

Reversal

Reversal holds up as well. Related to momentum, this is the idea that stocks with extreme up or down stock price reactions tend to bounce back over short periods. Again, reversal has a smaller impact on the older data period than with more recent data.

Size

The size effect is that smaller stocks tend to outperform larger ones. Again, this is evident in the earlier data period, though as with more recent history it has a smaller effect on market returns than other well-known factors.

Limitations

This is subject to the usual issues with data-based analysis in that returns could still be spurious and markets change over time, especially as trading costs decline and information flow improves. That said this data does offer a helpful, additional perspective on factors that have held up well both in the U.S. and internationally.

Even though the market does evolve over time, it seems that many of these factors perhaps related to human nature, may persist over the long run.