Does History Repeat Itself? Business Cycle and Industry Returns
62 Pages Posted: 4 Jul 2016 Last revised: 11 Nov 2019
Date Written: November 9, 2019
Industries with higher historical business cycle regime Sharpe ratios (RSR) have higher regime-dependent expected returns. Conditional on whether output gap is positive or negative, an out-of-sample long-high-RSR and short-low-RSR sector rotation strategy generates 14.02% annualized alpha in Fama-French five-factor model during 1985-2014. Industry momentum and related anomalies are unlikely to be the source of alpha. Firms in long portfolios have stronger fundamentals, more upward analyst forecast revisions, and more positive forecast errors. Our results suggest that investors don't fully incorporate business cycle variation in cash flow growth and highlight the importance of business cycle on the cross-section of industry returns.
Keywords: Business Cycle, Industry Returns, Sector Rotation Strategy, Cash Flow News
JEL Classification: E3, G1
Suggested Citation: Suggested Citation