Tag Archives: premium-authors

Jeremy Siegel’s Case For Equities

Jeremy Siegel has done more work on historical stock returns than pretty much anyone. He literally wrote the book on it, pulling stock data going back to 1802 for Stocks for the Long Run . In a recent Master in Business podcast interview he summed up his case for equities simply: What I showed was when you stretch out your holding period, up to 15, 20, 30 years, stocks actually were safer than bonds – had a lower variance and lower volatility than bonds. The long term, of course, gets overlooked with stocks. Everything – returns, variance, volatility – smooths out once you start to stack years together. I’ve broken down the S&P 500 returns over longer periods before. Since 1926, one-year returns range from a 54% gain to a 43% loss. If you put five years together, the annual returns range from a 29% gain to a 12% loss. Ten-year annual returns range from a 20% gain to a 1% loss. Fifteen-year annual returns range from a 19% gain to a 1% gain. Notice a trend? The range of possible returns shrinks as you extend the holding period. This is why stocks are Siegel’s asset of choice: If we know that return over that longer period of time is going to beat bonds by 3-4-5% per year, wow, that becomes the asset of choice for the long run. So why not only own stocks? Because people still fixate on one-year returns. It’s not much of a reach to suggest that fixation does more harm than good. It drives action. People look at one year’s return and expect it to continue. So money flows into stocks after a great year, and out after a terrible year. This need to act is why diversification is so important. Bonds become a psychological buffer for the short term craziness in the markets. And then there’s valuation. There are times when stocks become so expensive in the short term that it negates much of that long-term potential. The difficulty is in trying to time these periods because a high valuation doesn’t guarantee immediate poor returns – high priced stocks can always go higher in the short term – and valuation tools, like the CAPE ratio , don’t help the cause. Prior to the dot-com bubble, Siegel was a devout index fund fan: I was wedded to cap-weighted at the same time I said tech was crazy. And I didn’t know how to reconcile those two. Your typical index fund is market-cap weighted , which makes it extremely efficient. There’s just one big flaw. If a few stocks become wildly inefficiently priced (like internet stocks during the dot-com bubble) there’s no way to sell those stocks in a cap-weighted index. Rather, the cap-weighted index fund continues to buy more as the market cap rises. So Siegel’s solution was to change the weighting – essentially creating fundamentally-weighted index funds based on objective earnings data and opening the door for the rise of smart beta. Now, the fundamental weighting method isn’t perfect either. It won’t magically prevent a losing year. But if you’re only focused on one-year returns, it won’t matter anyway, you’ll be too busy acting before you ever see the benefits.

Dual ETF Momentum November Update

Scott’s Investments provides a free “Dual ETF Momentum” spreadsheet which was originally created in February 2013. The strategy was inspired by a paper written by Gary Antonacci and available on Optimal Momentum . Antonacci’s book ” Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk ” also details Dual Momentum as a total portfolio strategy. My Dual ETF Momentum spreadsheet is available here , and the objective is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative momentum. Invested signals also require positive absolute momentum, hence the term “Dual Momentum”. Relative momentum is gauged by the 12-month total returns of each ETF. The 12-month total returns of each ETF is also compared to a short-term Treasury ETF (a “cash” filter) in the form of the iShares Barclays 1-3 Treasury Bond ETF (NYSEARCA: SHY ). In order to have an “Invested” signal, the ETF with the highest relative strength must also have 12-month total returns greater than the 12-month total returns of SHY. This is the absolute momentum filter which is detailed in-depth by Antonacci, and has historically helped increase risk-adjusted returns. An “average” return signal for each ETF is also available on the spreadsheet. The concept is the same as the 12-month relative momentum. However, the “average” return signal uses the average of the past 3-, 6-, and 12- (“3/6/12”) month total returns for each ETF. The “invested” signal is based on the ETF with the highest relative momentum for the past 3, 6 and 12 months. The ETF with the highest average relative strength must also have average 3/6/12 total returns greater than the 3/6/12 total returns of the cash ETF. Portfolio123 was used to test a similar strategy using the same portfolios and combined momentum score (“3/6/12”). The test results were posted in the 2013 Year in Review and the January 2015 Update . Below are the four portfolios along with the current signals: (click to enlarge) As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker-specific, commission-free ETFs for TD Ameritrade, Charles Schwab, Fidelity, and Vanguard. It is important to note that each broker may have additional trade restrictions, and the terms of their commission-free ETFs could change in the future. Disclosure: None.

Why Long-Term Investors Need To Be Looking Overseas…

Summary Value opportunity in foreign markets. Developed markets facing multiple headwinds. Investors looking to go international face many obstacles. Over long-term investment horizons, valuations can be a valuable guide for portfolio allocation. Most recently, we here at AlphaClone have been struck by the current valuation divergence across global equity markets. We believe long-term investors should be looking to increase their allocations to international equities in their portfolios. Why? In a word, price. The case for favoring international equities over U.S. domestic equities all comes down to price. This table sums up the current situation. (click to enlarge) (Table Source ) Whether it is developed market central banking policies, or other economic factors that have led to developed markets being richly valued, the bottom line is that equity markets in the U.S. and other western markets are historically expensive. As you can see in the table above, United States equities trade for 24x their cyclically adjusted price-to-earnings ratio or CAPE ratio. The historic average for U.S. equities has been a CAPE of around 16x. If U.S. equities regress all the way back to their historic average of 16x CAPE over the next 10 years, then investors would be looking at a -4% per year headwind. As price multiples contract, earnings have to grow that much faster to maintain the same price growth levels. Even if we only go only half way back to a 20x CAPE ratio, that would represent a -2% per year headwind for U.S. investors. All of these headwinds would predict anywhere from a positive 1% to potentially negative -2% real return for U.S. equities over the next 10 years. That is a lot of headwind for the investor who invests solely in the U.S.! Meanwhile… In the international markets and emerging markets, in particular, their average CAPE is just 13x. What’s more, if you focus in on just value stocks within emerging markets, you can find an average CAPE of 8.5x for those stocks. These markets have been hammered over the last three years but now they may offer compelling value to the patient long-term investor. This opportunity means investors can get almost 2-3x times as much value for their invested dollar through investing in stocks internationally as they can from buying the U.S. broad market indices. If you’ve invested Internationally, you’ve lived this growing valuation divergence. Through November 4, 2015, Morningstar’s Foreign Large Blend equity fund category is -4.8% in the past three months compared with their U.S. Large Blend equity fund category -0.6%. This foreign category is dominated mostly by actively managed funds. Annualized returns for longer periods can be seen below. (click to enlarge) Is the time right for foreign equities to start outperforming U.S. domestic equities? Timing is always difficult, but we believe that this is the area where patient long-term investors should be looking for value to increase their international equity portfolio allocations and take advantage of the discount they represent. How should you do it? Even if you are convinced of the opportunity that exists internationally, how should an investor best do it? International investing brings with it a host of additional challenges for investors including: Which countries to choose Which sectors to pick Which securities to select Foreign currencies issues When to enter/exit trades Tax implications What visibility do you have But probably the most important question is which managers should you trust to help you navigate the above obstacles over the long term. If the table above shows you anything, it shows you how difficult it’s been historically for active managers to beat the broader, cap-weighted market benchmarks. Despite the under performance recently of active management in the international arena, active management is still probably the best choice for long-term investors who would like a solution that can adapt to the changing market environments we are likely to face, and who would like to add a value tilt in their foreign investing.