Zacks, The Handbook of Equity Market Anomalies

Leonard Zacks, the founder of Zacks Investment Research, has edited a book that should appeal to serious investors who are trying to find an edge. The contributors to The Handbook of Equity Market Anomalies: Translating Market Inefficiencies into Effective Investment Strategies (Wiley, 2011) are mostly academics. They review literature from the past twenty years on market anomalies and draw practical implications for the individual investor.

After an introductory chapter on the conceptual foundations of capital market anomalies, the book highlights nine anomalies: the accrual anomaly, the analyst recommendation and earnings forecast anomaly, post-earnings announcement drift and related anomalies, fundamental data anomalies, net stock anomalies, the insider trading anomaly, momentum (the technical analysis anomaly), seasonal anomalies, and size and value anomalies. The editor then looks at anomaly-based processes for the individual investor, and an appendix covers the use of anomaly research by professional investors. As you might expect, each chapter includes an extensive bibliography. (The website that accompanies the book has abstracts of the referenced works and links to the original articles—some available at no charge.)

The authors explore strategies that worked, that still work, and—the toughest hurdle of all—that continue to produce excess risk-adjusted returns after all those pesky transaction costs are deducted.

Many of the anomalies can be attributed to psychological factors. To take perhaps the simplest case, sunshine has been linked to tipping and the lack of sunshine to depression and suicide. When the sun shines people feel good, are more optimistic, and “may be more inclined to buy stocks thus leading to higher stock prices.” (p. 255) Indeed, studies show, sunshine is strongly positively correlated with daily stock returns, especially the farther one is from the equator. Other weather conditions such as rain and snow are unrelated to returns.

A question that I found intriguing is whether aggregate insider trading can be used to predict market returns. (Studies suggest that insider trading as an individual stock picking strategy delivers superior returns over long investment horizons.) Insiders, it turns out, are contrarian traders; they sell after increases in the market and buy after poor performance. So far studies indicate that “aggregate insider trading is more successful in predicting forthcoming poor stock market performance, but it can also be used with moderate success to predict large stock market increases. Aggregate insider transactions have a promising potential to be used as a market-timing tool.” (p. 166)

Zacks suggests that research on these anomalies be used to create quant multifactor equity models. The investor can embrace that suggestion if she has some quant skills, can subscribe to a scanning service (Zacks Investment Research, of course, provides such a service), or can use select anomalies to supplement her current investing strategy. No matter what the choice, this book is a cornucopia of carefully researched investing ideas.