In this video I will give you another intermission on a stock Spader factor.
And still we have important.
The returns data frame and the summary data frame with the more realistic market portfolio with the
weights corresponding to the market capitalization.
So here they m cap portfolio.
And here we can see on the right hand side that the beta effect pretty much differs.
We have a beta effect of one point for two for Amazon and only a beta factor of four point three six
for Coca Cola.
And by definition we have a better effect of one for the market portfolio.
And we actually learned before that the beta affect us that the slope of the regression line between
the returns of the market cap portfolio and the returns of the stock and also for this example here
we can draw the regression line between the market portfolio and the Amazon stock and we take you the
daily returns that we have and our returns data frame and on the x axis we have the market portfolio
returns and on the y axis the Emmerson returns.
So let's have a look again here.
So that's where the regression line and the slope of the regression line is actually the Peter factor
and in our example here the slope should be a one point for two and we can also check this again with
the pie and the poly fed function.
So let's have a look here and this is the case here.
So the slope is one point for two.
So from a practical perspective what does a slope of a one point four mean.
And let's assume that the return of the market portfolio increases by 1 percentage point.
So for example from 2 percent at the 1 day to 3 percent at a day then with a bead effect of one point
four on average the return of these stock increases by one point four percentage points and the same
holds true for negative returns.
So if the market portfolio return decreases by 1 percentage point then the stock return on average decreases
by one point 4 percentage points.
In a way this stock overreacts to the market and is therefore called a cyclical stock because it is
heavily driven by market cycles.
So that's the Amazon stock.
And in contrast we have here the Coca-Cola stock with a beta of far below 1 so point 3 6.
And let's also plotted the regression line for the Coca-Cola stock.
So again we have the market portfolio on the x axis here
and the slope here is the Coca-Cola Spader factor and the intuition is that if the market portfolio
return increases by 1 percentage point then the return of the Coca-Cola stock only increases by 0 point
3 6 percentage points.
So in a way the Coca-Cola stock under reacts to the market and is therefore called a non cyclical stock
or defensive stock because it's less influenced by the overall market.
And the question is now why are some stocks and industries cyclical and others defensive.
And the answer is that the cyclical stocks that typically sell luxury products are very expensive products
that are not essential for life slow examples could be car manufacturers or producers of luxury watches
and during economic growth or upswings these businesses capture most of the increases in spending as
consumers are more willing to spend their additional earnings on luxury items.
And in contrast during economic recessions consumers reduce their spendings as they tighten their budgets
and they spend their money on essential goods like food gas electricity and so on.
So Amazon is a cyclical stock as people tend to order more smartphones than upswings.
And once the economy weakens that they stop buying things on Amazon they actually do not really need
for life.
So Coca-Cola is a non cyclical stock as the demand for Coke remains pretty sticky and independent of
the state of the economy are in simple words that people drink Coke no matter if they are unemployed
or successful and the coke is actually an essential everyday product.
All right.
Let's move on and let's have an additional graphical intuition on it so we download price data for Amazon
and Coca-Cola from 2000 and 8 to 2000 and 18 and we only select the closing prices
and finally we read sample the prices to monthly frequency and we calculate uh monthly returns and finally
monthly rolling mean returns with a window of twelve months and we actually uh plotted to for Amazon
and for Coca-Cola and let's have a look here.
So here we have Amazon.
And here we have Coca-Cola
and it's pretty easy to see here that the rolling return for Amazon is more volatile and it actually
overreacts market cycles.
And here for Coca-Cola we can see that the rolling returns the less amplify it so actually at another
reacts the market now.
The final question is what are the implications of these findings for an investor.
So let's assume an investor predicts our fears some market turbulence in the near future then it might
be a good idea to decrease market risk and that means that the investor should decrease the average
beta effect of his portfolio by investing in defensive stocks.
All right.
And with this we are finished here and I hope to see also in the next video by.