Factor Analysis

Factor Analysis


Data on this page was last updated on May 18, 2023


Remember it is direction not regression. Many economists and asset managers rely on regression analysis for prediction. Regression has its place for measuring sensitivity, but it does a poor job of forecasting future returns. Instead, please focus on the direction of the economic driver and the impact it has on the path of asset classes.


Besides the apparent correlation between high yield and investment-grade credit risks and the correlation between real rates and long-term rates, there is a low correlation between the factors. Credit risk is one factor, but there is an advantage to measuring the difference between high yield and investment grade, representing the default risk of indebted corporations. Likewise, the difference between rates and long-term rates holds critical distention for duration (term) risk.

Economic Growth


The reward for taking on the risk of economic uncertainty. Growth-sensitive assets rely on economic expansion to generate strong returns, and will suffer when the global economy is weak.

Earnings Yield


The earnings of corporations are similar to fixed-income payments; they provide cash flow or a return of equity to shareholders. Earnings are also sensitive to interest rates; the higher the interest rate, the more you have to discount payments into the future. Earnings yield is simply earnings over price, instead of the traditional price over earnings (P/E ratio).

Earnings yield shows us several good decision flows. It acts as a growth indicator of corporate profit and adds a valuation tool. The lower the market yield, the higher the valuation level.

Risk Free Rate


The movements in this variable can be a proxy for changes in short-term interest rates, which central banks typically set in the conduct of monetary policy and is considered to be a risk free rate.

Real Rates


Rate-sensitive assets have tended to perform well when real rates are falling, and suffer when rates rise. This factor is designed to track real yields with intermediate maturities.

Credit Risk


Investors can earn a premium for lending to corporations (rather than governments), bearing the risk of issuer default. Investment Grade credit risk is associated with bonds that have a high credit rating. Credit premiums are also linked to the strength of the global economy.