The strategy uses 13 firm fundamental ratios, adjusting for seasonality and shocks. Forecasted returns are calculated using partial least squares (PLS), with stocks sorted into deciles, long top decile, short bottom decile.
ASSET CLASS: stocks | REGION: United States | FREQUENCY:
Quarterly | MARKET: equities | KEYWORD: Momentum, Fundamental
I. STRATEGY IN A NUTSHELL
Ranks U.S. stocks using 13 seasonally adjusted fundamental ratios and quarterly shocks, aggregated via partial least squares. Goes long on the top decile and short on the bottom decile of forecasted returns, with quarterly rebalancing.
II. ECONOMIC RATIONALE
Firm fundamentals are cyclical, driving momentum after positive shocks and reversals following negative shocks. Stock return patterns reflect rational responses to these changing fundamentals rather than behavioral biases, making rebalancing timing critical.
III. SOURCE PAPER
Firm Fundamental Cycle and Cross-Section of Stock Returns[Click to Open PDF]
Yufeng Han, Zhaodan Huang, Weidong Tian, and Guofu Zhou — University of North Carolina (UNC) at Charlotte – Finance; Utica University; University of North Carolina (UNC) at Charlotte – The Belk College of Business Administration; Washington University in St. Louis – John M. Olin Business School
<Abstract>
We construct firm fundamental indexes to summarize a firm’s broad range of business activities, and show that firms experience fundamental cycles similar to the business cycles of the aggregate economy. We find that momentum and long-term reversal are manifestation of the different stages of firm fundamental cycles. In addition, a fundamental-based factor explains factor momentum, and adding it into the Fama and French (2015) five-factor model, raises the fraction of anomalies explained from 37% to 80% out of a comprehensive set of 247. Our evidence shows that it is economic forces rather than behavioral biases, that are the main drivers of anomalies.
IV. BACKTEST PERFORMANCE
| Annualised Return | 8.8% |
| Volatility | 6.82% |
| Beta | N/A |
| Sharpe Ratio | 0.7 |
| Sortino Ratio | N/A |
| Maximum Drawdown | -21.44% |
| Win Rate | N/A |
