Morningstar on Investment Truths

A recent article in Morningstar recounts insights from AQR’s Cliff Asness on the following two questions:

  1. Can current stock valuations help predict future returns?  “Probably yes,” writes Asness, “but not for the reason you think.” The article cites an AQR paper that highlights the problem with making predictions from long-term stock market figures such as the Shiller P/E ratio. The paper concludes that “without building economic structure into the modeling, there is little hope of documenting reliable statistical evidence of long-horizon predictability.”
  2. What is the size of the small-company effect?  “Nothing,” says Asness, who argues in another AQR paper that, “Among other issues, the data used to discover it was flawed (though no fault of the author, that was the data back then) in a way that favored small stocks.” The paper reports that from 1936 through 1975 there was a “weak” size effect that lacked statistical significance. Over the past 30 years, the AQR authors argue, the effect has further weakened and has all but disappeared since 1986. “Since the slew of publications on the size effect,” the paper assets, “there has been no significant positive premium associated with small-cap strategies.”