Industries and the Market

Story:

One of my favorite financial economics article is Professor Harrison Hong's 'Do Industries Stock Lead Stock Markets?'. In this article, they investigated whether the returns of industry portfolios are able to predict the movements of stock markets. They findings suggest that stock markets react with a delay to information contained in industry returns about their fundamentals and that information diffuses only gradually across markets.

In biochemistry, you might see one term - signaling - quite often. And you might hear biochemist talking about feedback mechanism a lot as well. Well, the feedback mechanism basically indicates that the signaling/regulating process is mutually interactive, which means the signals are passing through 2 directions- to the downstream and upstream/itself. From my perspective, financial information network is similar to the complicated biological signaling process. Information is passing to everywhere through the bridges/vehicles it can find. The idea stimulated me to have a simple extensive experiment regarding Professor Hong's findings.

Results:

Part I: Strategies directly translated from Hong's idea. (Figure 1&2)

Strategy: Using Hong's idea as a predictor for market's trend, long or short S&P500 according to the predictor.

Prediction accuracy: 68%.

Figure 1. Long-only and long-short strategies translated from Hong's idea using Fama-French 10 industrial portfolios.

Figure 2. Long-only and long-short strategies translated from Hong's idea using Fama-French 48 industrial portfolios.

Part II: Some Industries lead other industries !?

(To be finished...)

Telecom in Fama-French 10 industry portfolios:

Above is the regression result for Telecom industry. We can see that the coefficient of energy sector is significant and it is negative.

Smoke in Fama-French 48 industry portfolios: