OK, I asked Grok about LowVol stocks during recovery phases.
Part of the reply is below. Overall, it appears than throughout market cycles, Low Volatility beats the High Betas. During early recovery, High Beta stocks outperform Low Volatility - which may still play a part in providing lower risk. In other words, during recoveries combine low volatility and aggressive high beta growth stocks.
Sounds a little complicated. But, we shall see. Here’s the copy of the last couple of studies from the reply - plus Grok’s summary and analysis. [Edit - one more point - afaik, over very long periods of time, apparently, Value beats all other factors. But, that hasn’t happened in a long time.]
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5. Baker, Bradley, and Wurgler (2011) - Benchmarks as Limits to Arbitrage
- Study: Published in the Financial Analysts Journal, this study examined why the low-volatility anomaly persists.
- Findings: The authors argue that institutional investors’ focus on benchmark outperformance leads to overinvestment in high-volatility stocks, leaving low-volatility stocks undervalued. This creates opportunities for low-volatility strategies to outperform over time.
- Relevance to Recovery: During bear market recoveries, when investor sentiment shifts from panic to cautious optimism, low-volatility stocks may benefit from renewed interest in undervalued, stable companies. The study suggests that low-volatility stocks could see strong performance in recoveries as capital flows back to defensively positioned firms, though it doesn’t explicitly analyze recovery periods.
6. Paye and Wang (2020) - Volatility Predictability in Bull and Bear Markets
- Study: Published in the Journal of Applied Economics, this study examined stock volatility predictability across bull and bear market states using high-frequency data from 1998 to 2016.
- Findings: Volatility forecasting is more accurate in bear markets, and low-volatility stocks exhibit greater predictability during these periods. The study found that bear markets are characterized by higher volatility and lower returns, while bull markets (including recoveries) show lower volatility and higher returns.
- Relevance to Recovery: The study suggests that low-volatility stocks may perform well in the transition from bear to bull markets (i.e., recovery phases) as volatility declines and investors seek predictable returns. However, the study notes that low-volatility stocks may underperform high-beta stocks in early recovery phases due to their defensive nature, with stronger relative performance in later, more stable recovery stages.
7. Li et al. (2016) - Low-Volatility Investing and Market Cycles
- Study: Published in the Journal of Investment Management, this study analyzed low-volatility strategies across market cycles, including bear and bull phases.
- Findings: Low-volatility portfolios outperform the broader market over full market cycles, with significant downside protection in bear markets. In bull markets, including recoveries, they tend to lag high-beta stocks but still deliver positive absolute returns.
- Relevance to Recovery: The study explicitly notes that low-volatility stocks underperform in the early stages of bull markets (e.g., recoveries) when high-beta, growth-oriented stocks lead the rebound. However, as recoveries mature and volatility subsides, low-volatility stocks often regain favor, delivering steady returns with lower risk. This suggests a nuanced role for low-volatility stocks in recovery periods.
### Synthesis and Observations
- General Performance in Recoveries: Academic studies consistently show that low-volatility stocks outperform high-volatility stocks over long periods due to the low-volatility anomaly. However, during bear market recoveries, their performance is context-dependent:
- Early Recovery (High-Beta Rally): In the initial stages of a recovery, high-beta, cyclical, and growth stocks often lead due to sharp rebounds in investor risk appetite. Low-volatility stocks, with lower betas (typically 0.5–0.7), tend to lag during these phases, as noted in Blitz and van Vliet (2007) and Li et al. (2016).
- Later Recovery (Stabilization): As recoveries mature and markets stabilize, low-volatility stocks often perform well, benefiting from investor demand for stable, high-quality companies. Studies like Paye and Wang (2020) suggest that declining volatility in bull markets favors low-volatility strategies.
- Downside Protection and Recovery: Low-volatility stocks excel in bear markets by limiting losses, as documented in multiple studies (e.g., Blitz and van Vliet, 2007; Baker et al., 2011). This downside protection means they start recoveries from a higher base, potentially requiring less price appreciation to reach pre-bear market levels compared to high-volatility stocks.
- Empirical Evidence: Data from the MSCI USA Minimum Volatility Index (cited in Hulbert’s 2019 analysis) shows that low-volatility stocks outperformed the S&P 500 by 10.39 percentage points annually during bear markets but trailed by 3.0 percentage points in bull markets, including recoveries. Specific recovery-phase data is scarce, but this suggests a lag in early recovery stages.
- Challenges in Recovery Analysis: Most academic studies focus on full market cycles or bear market declines, with less granularity on recovery periods. This is partly because recovery phases are short and harder to isolate statistically. Studies like Paye and Wang (2020) provide some insight into the transition from bear to bull markets, but more targeted research is needed.
### Practical Implications for Investors
- Strategic Role: Low-volatility stocks are not typically the top performers in the early, high-momentum phase of bear market recoveries. Investors seeking to capitalize on sharp rebounds may prefer high-beta or cyclical stocks. However, low-volatility stocks offer stability and consistent returns, making them suitable for risk-averse investors or those prioritizing capital preservation during uncertain recoveries.
- Portfolio Construction: Combining low-volatility stocks with selective exposure to high-beta stocks during recoveries could balance risk and return. Diversification across asset classes, as suggested by studies on bear market strategies, also enhances resilience.
- Timing Considerations: Academic evidence suggests that low-volatility stocks shine in longer, more stable recovery phases. Investors may benefit from holding these stocks through bear markets and into recoveries, avoiding the temptation to chase high-beta rallies.
### Limitations and Gaps in Research
- Lack of Recovery-Specific Studies: Few studies explicitly analyze low-volatility stock performance in the recovery phase, as most focus on bear or bull market states broadly. This gap limits definitive conclusions about recovery performance.
- Data Constraints: Many studies rely on historical simulations (e.g., 20–90 years of data), which may not fully reflect modern market dynamics, such as high-frequency trading or policy interventions during recoveries.
- Valuation Risks: High valuations of low-volatility stocks, as noted in the late 2010s, can reduce their attractiveness in recoveries if they become overcrowded trades.
### Conclusion
Academic studies confirm that low-volatility stocks outperform high-volatility stocks over long periods and provide significant downside protection in bear markets. During bear market recoveries, they tend to lag high-beta stocks in the early, high-momentum phase but perform well in later, more stable stages as volatility declines and investors seek quality and predictability. Key studies, such as Haugen and Heins (1975), Fama and French (1992), Blitz and van Vliet (2007), and Paye and Wang (2020), support the low-volatility anomaly’s persistence across market cycles, with implications for recovery periods. However, more targeted research on recovery phases is needed to draw definitive conclusions. For investors, low-volatility stocks remain a valuable component of a diversified portfolio, particularly for those prioritizing stability during volatile recoveries.
If you’d like, I can search for additional studies or analyze specific datasets (e.g., MSCI USA Minimum Volatility Index performance during past recoveries) to provide more granular insights. Let me know! |
