Industry Classification (007.0)

In this post, we look at the results of our random forest model with and without one variable, the 2 digit industry classification code. I have been worried that the random forest might do a good job explaining the past, but fail to predict the future. Specifically, in any month industry may explain performance, but this may not persist. So I compare forecasts with and without the industry variable. Note this post also updates the performance from previous posts (5.0). The 12 month return now includes dividends (the one month does not).

Two random forests, one with and one without the industry variable, are created for each month. Each forecast uses the 12 most recent forestswhose response variable (1 or 12 month forward return) does not overlap with the forecast period. Portfolios are constructed using the top (Long) and bottom (short) 50 companies weighted by market cap. In the following tables CWLong, CWMkt, and CWShort are the long, universe, and short portfolios each of which is capitalization weighted.

The mean of the 1 month returns for the Long portfolio improve with the addition of the Industry variable. However, the Short portfolio’s performance deteriorates. When the horizon shifts to 12 months, the story reverses. The mean return for the Long portfolio goes down which is bad, and the mean goes down for the Short side which is good. The same observations hold if we examine the medians. Following the section looking at capitalization weighted portfolios are panels with equal weighted portfolios. These two give no indication that Industry helps or not.

1 Month Forward Cap-Weighted Without Industry Variable

##      CWLong             CWMkt             CWShort         
##  Min.   :-25.0564   Min.   :-19.2347   Min.   :-29.79002  
##  1st Qu.: -3.0758   1st Qu.: -1.9693   1st Qu.: -5.22418  
##  Median :  0.7567   Median :  1.1215   Median :  0.07273  
##  Mean   :  0.8564   Mean   :  0.4519   Mean   : -0.72252  
##  3rd Qu.:  6.4135   3rd Qu.:  2.9843   3rd Qu.:  5.62011  
##  Max.   : 22.1514   Max.   : 11.5276   Max.   : 36.56759

1 Month Forward Cap-Weighted With Industry Variable

##      CWLong            CWMkt             CWShort        
##  Min.   :-30.207   Min.   :-19.2347   Min.   :-28.1153  
##  1st Qu.: -3.211   1st Qu.: -1.9693   1st Qu.: -5.8952  
##  Median :  1.448   Median :  1.1215   Median :  0.4848  
##  Mean   :  0.988   Mean   :  0.4519   Mean   : -0.6010  
##  3rd Qu.:  6.274   3rd Qu.:  2.9843   3rd Qu.:  5.1642  
##  Max.   : 22.144   Max.   : 11.5276   Max.   : 39.0297

12 Month Forward Cap-Weighted Without Industry Variable

##      CWLong            CWMkt            CWShort       
##  Min.   :-60.284   Min.   :-44.723   Min.   :-81.609  
##  1st Qu.: -4.463   1st Qu.:  1.611   1st Qu.:-17.743  
##  Median : 14.740   Median : 12.694   Median :  5.290  
##  Mean   : 12.498   Mean   :  9.088   Mean   :  2.066  
##  3rd Qu.: 28.708   3rd Qu.: 19.822   3rd Qu.: 19.844  
##  Max.   :127.020   Max.   : 54.506   Max.   :137.777

12 Month Forward Cap-Weighted With Industry Variable

##      CWLong            CWMkt            CWShort       
##  Min.   :-54.542   Min.   :-44.723   Min.   :-82.243  
##  1st Qu.: -6.344   1st Qu.:  1.611   1st Qu.:-20.378  
##  Median : 12.689   Median : 12.694   Median :  1.447  
##  Mean   : 11.853   Mean   :  9.088   Mean   :  1.208  
##  3rd Qu.: 27.948   3rd Qu.: 19.822   3rd Qu.: 19.987  
##  Max.   :116.021   Max.   : 54.506   Max.   :129.747

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1 Month Forward Equal-Weighted Without Industry Variable

##      EWLong             EWMkt             EWShort        
##  Min.   :-22.5662   Min.   :-22.0680   Min.   :-26.4810  
##  1st Qu.: -2.9836   1st Qu.: -2.2024   1st Qu.: -5.8129  
##  Median :  1.6373   Median :  0.9782   Median :  0.6304  
##  Mean   :  0.7422   Mean   :  0.5502   Mean   : -0.4584  
##  3rd Qu.:  6.2936   3rd Qu.:  3.7127   3rd Qu.:  5.2619  
##  Max.   : 14.2837   Max.   : 15.2458   Max.   : 42.0121

1 Month Forward Equal-Weighted With Industry Variable

##      EWLong             EWMkt             EWShort        
##  Min.   :-27.0288   Min.   :-22.0680   Min.   :-28.1130  
##  1st Qu.: -3.4585   1st Qu.: -2.2024   1st Qu.: -5.3856  
##  Median :  1.7828   Median :  0.9782   Median :  0.0587  
##  Mean   :  0.5984   Mean   :  0.5502   Mean   : -0.6075  
##  3rd Qu.:  6.6981   3rd Qu.:  3.7127   3rd Qu.:  5.0069  
##  Max.   : 16.2420   Max.   : 15.2458   Max.   : 46.6432

12 Month Forward Equal-Weighted Without Industry Variable

##      EWLong            EWMkt            EWShort        
##  Min.   :-55.673   Min.   :-46.080   Min.   :-63.2369  
##  1st Qu.: -3.466   1st Qu.: -2.215   1st Qu.:-15.3299  
##  Median : 11.500   Median : 11.181   Median : -0.3121  
##  Mean   :  8.830   Mean   :  9.789   Mean   :  3.1968  
##  3rd Qu.: 23.330   3rd Qu.: 23.135   3rd Qu.: 17.6079  
##  Max.   : 58.384   Max.   : 69.086   Max.   :154.7558

12 Month Forward Equal-Weighted With Industry Variable

##      EWLong            EWMkt            EWShort       
##  Min.   :-60.601   Min.   :-46.080   Min.   :-67.846  
##  1st Qu.: -2.499   1st Qu.: -2.215   1st Qu.:-14.321  
##  Median : 11.302   Median : 11.181   Median : -1.521  
##  Mean   :  9.240   Mean   :  9.789   Mean   :  3.142  
##  3rd Qu.: 22.538   3rd Qu.: 23.135   3rd Qu.: 18.316  
##  Max.   : 83.884   Max.   : 69.086   Max.   :144.181