Five clues
Monday, November 5, 2018
By Tom Snee

Investors can glean clues about the market’s future direction with help from a new study from researchers at the University of Iowa’s Tippie College of Business. They have developed a corporate management activity index based on how managers’ run their firms that could improve an investors’ return by more than 4 percent.

Clues to Look For

  1. Merger and acquisition financing. Analyzing the aggregate amount of stock that is being used across the market to finance mergers and acquisitions, in lieu of cash, is a significant tell. The more stock that firms are using to finance their M&A activity, the more likely that future stock returns will be low.
  2. Employee investments. The more insiders purchase their company’s stock, the more likely that future stock returns will be positive.
  3. Corporate investments. Firms that invest more money into research and development when their stock prices trend low provide clues about their managers’ beliefs in the firm’s future growth.
  4. Equity issues. The more companies are issuing stock, the more likely the market is to drop. Studies have found companies are more likely to issue stock when the current price is overvalued.
  5. Share repurchases. If many firms are repurchasing at roughly the same time, then the overall stock market is likely undervalued and stock prices can be expected to rise soon.

Bottom Line

The researchers find that an index of corporate activities has substantially greater predictive power for market returns than indexes using other economic variables. The index also yields much greater economic gains. For example, a typical investor would see a 4.6 percent increase in annual returns using their model over returns that investors will have gained using other predictive models. 

The study, “Corporate Activities and the Market Risk Premium,” was authored by finance doctoral student Bo Meng of the University of Iowa, finance professors Erik Lie and Yiming Qian of the University of Iowa, and Guofu Zhou of Washington University. Find it online here