Institutional investors are often faced with the question of which factor strategies should be implemented in different phases of the economic cycle. In this paper, we examine how factors behave across economic cycles for the US market.

  • Over a long period, we find that Size and Value have anticipated subsequent inflections in GDP growth, while Quality has anticipated contractionary periods. The results are intuitive as Value and Size are more likely to do well when the outlook for the economy is good, whereas Quality provides protection when investors are more nervous about an economic decline. Momentum is found to contain little information about the macro-economy.
  • We apply the Investment Clock framework to create four economic cycles based on different combinations of economic growth and inflation expectations. We find that Quality tends to do well at the peak of the cycle and continues to do so into a contraction; then, when the market hits its trough, Value, Size and Momentum tend to be the best performing factors; subsequently, Value fails, but Size and, in particular, Momentum continue to do well into an expansion.
  • However, we have observed lower average factor returns since the post-Global Financial Crisis (GFC) period, which was characterized by quantitative easing, and 12 years of stagnation. We will examine this phenomenon in more detail in our Part 2 report.