Dynamic Z-score Asset Allocation to Size, Value, and Industry Return Shocks

Abstract

This study examines short-term diverging returns between popular asset classes such as value vs growth, small vs large, and significant industry return divergences to determine if switching strategies can take advantage of relative valuations. Findings show Z-scores based on 1 to 3-month cumulative returns relative to the previous year are positively related to the proceeding one-month excess return. For size, value, and growth, the asset class that significantly outperforms their counterpart over six months or longer mean reverts. Industries significantly outperforming from one to six months are found to continue to do so. These results hold up across various time frames from 1926 through 2022 and outperform a simple buy-and-hold strategy over multiple time periods. Practical application using ETFs over the last 20 years continue to show success for size and value, but industry switching does not outperform a simple buy-and-hold strategy.