Some stocks tend to price reversion, while others tend to price extension. "Reversion" means current strength leads to weakness, and weakness leads to strength. "Extension" implies trendiness, where strength begets more strength, and weakness further weakness. Both reversion and extension periods may span days or weeks or months.
The VaR/X model quantifies and profiles reversion and extension behavior. The model tests a range of cycle spans, quantifying subsets and identifying span sets of significant pattern. VaR/X detects more subtle response behaviors than conventional cycle searches can.
VaR/X also measures overall efficient behavior against the standard of randomness. Stock-picking inherently implies a search for mis-pricing, and mis-pricing requires inefficiency. Although inefficient price behavior can't assure mis-pricing, highly efficient behavior is clear evidence against it. Price efficiency poses a serious challenge to any stock selection strategy.
Here are 5-year average VaR/X values for five broad market indexes:
|VaR/X & Net Efficiency; 5 Years ending 6/30/03|
(VaR/X values less than 1.000 indicate reversion; values greater than 1.000 indicate extension. Net Efficiency is always <= 100%)
Individual sectors and stocks vary behavior more widely than broad indexes. In the same 5-year period as the table above, the DJ Healthcare sector had a VaR/X value of .773, while the DJ Real Estate index had VaR/X of 1.430. (Both values are statistically significant, with Net Efficiency below 70%.) VaR/X values like these identify opportunity.
Here are three recent and very different VaR/X profiles for three widely followed stocks:
Berkshire Hathaway shows slight "extension" behavior over very short spans, with reversion dominating overall.
The Krispy Kreme profile is thoroughly extensive, suitable for momentum strategies.
Starbucks is plainly reversionary, suitable for "accumulation" strategy but not to momentum strategy.
The WSJ (Sept 22, Nov 28 2003) reports high-yield bonds are great for timing and momentum strategies, because they "trend smoothly." VaR/X shows that clearly. The 3 year VaR/X profile on the Merrill High-Yield index averages 3.50x normal. (Contact us below for current values.)
To enquire about VaR/X applications with your own stocks and funds, you can leave a message back at the Models page, or use the master checklist of Analytix Services. Or call directly anytime, at (603) 643-6430.