Opportunity always exists. A naive understanding of the data would certainly suggest otherwise.Think back to 1982, when many U.S. based investors had given up all hope. This absolute sense of hopelessness did have a basis in long-term asset class returns. Consider the following four popular asset categories (inflation-adjusted total returns) :
U.S. stocks, S&P 500 Index
-0.03% per year for the 19.2 years ending 7/31/1982
U.S. treasuries, 10-year maturity
-0.01% per year for 84.6 years ending 9/30/1981
U.S. corporate bonds, AAA-rated, long-term maturity
-0.01% per year for 49.6 years ending 9/30/1981
Diversified global commodities, Reuters Jeffries CRB Index
-0.04% per year for the 14.3 years ending 11/30/1993
Nevertheless, I would maintain that opportunity always exists. Some, if not most, would then jump to the (false) conclusion that I am suggesting the solution to the episodic, long-duration “zero” returns depicted above is market timing. Nothing could be further from the truth. Granted, I have nothing against market timing, its logic is remarkably straightforward and obvious. Get out of the market right before it declines, stay in cash, and then right before it goes back up, get back in. A simple, straightforward investment process – no one could ask for anything more. Unfortunately, market timing is one of the most fragile decision processes in existence. By “fragile,” I mean that unless the timing decisions are unbelievably accurate, it will absolutely fail.
So what is my basis for my claim that opportunity always exists – given the very long duration zero return environments noted above and my obvious rejection of market timing. If one considers all geographies and all asset categories, then one discovers that no matter what the period, no matter how dark and gloomy the sky, several asset classes (somewhere) are always generating remarkably large and truly outsized returns.
But perhaps even more important than this observation, is that such large and outsized returns are not short-duration or just the “whim of the moment.” Instead, episodic or secular eras unfold, during which a host of select asset categories have always excelled. Their respective outperformance has tended to be very long-duration. This last aspect is critical, because it neutralizes the desperate (and misguided) need to “time” the entrance or exit from such opportunities. One could be off by a month, or a year, or even two, and still realize an adequate bite of the apple.Let me provide some data to make this a bit more real.
2000 to Present.Consider the last several years, 12/31/1999 through 10/01/2012. This was a disastrous period for the S&P 500, which lost -11% (after adjustment for inflation, unannualized). Nevertheless, handsome triple-digit inflation-adjusted returns existed:
Silver (+368%) Gold (+349%)
US REITs (+223%) Copper (+215%)
Australia 10-year treasuries (+210%) New Zealand 10-year treasuries (+209%)
Australia stocks (+174%) Corn (+193%)
The exact same secular drivers drove all of these returns. This episodic era experienced a global commodity and real asset boom driven in part by the growth of an emerging middle class within the developing countries. This period was secular and episodic. One could have gotten the “timing” wrong by years, allocated only a smaller portion of their portfolio to these types of asset categories, and still earned a handsome return.
1970s.Or consider the 1970s during which the S&P 500 delivered -14%, US corporate bonds -10%, and 10-year US treasuries -11% (after inflation). Nevertheless, during this decadeinvestors could have experienced triple-digit returns (after inflation), e.g.:
Gold (+704%) Silver (+665%)
Oil (+482%) Oil stocks (such as Marathon Oil +211%)
Norway stocks (+166%)
As before, all of these returns were based on a common set of secular drivers – in this case, rapidly rising domestic and global inflation in combination with a global energy supply/demand imbalance. This was a secular, episodic era during which timing was irrelevant, only participation mattered.
1910s.If we go significantly further back in time, to the 1910s, we find a period that parallels today’s environment to a minor degree. This decade was characterized by:
- A massive expansion of auto production (and the consequent demand for gasoline)
- The Spanish flu resulting in the death of between 20 and 25 million people
- World War I
- A record number of labor strikes in the U.S. (with 4,450 labor strikes in 1917 alone)
- Largeconsecutive tax rate increases
- Rapid, if not historic, expansion of the money supply
- Skyrocketing inflation
- Government directed breakup of large business
As a consequence, the after-inflation returns to domestic asset categories were: S&P 500 (-25%), 10-year US treasuries (-37%), US corporate bonds (-31%), and US single-family homes (-32%). Nevertheless, as with every other secular era, opportunity abounded:
- Nothing creates greater investment opportunity than governmental intervention. This is virtually a universal truth. I don’t mean this as a criticism of government. Instead, it is a recognition that government intervention is almost universally conducted for non-economic or non-value based reasons. Such actions then serve to distort market prices, serving to create robust and bountiful investment opportunities. The government’s breakup of the Standard Oil Company provides a prime and classic example. Standard Oil was broken up into 34 separate and independent companies, who then proceeded to takeover the energy market at an unstoppable pace. Shareholders earned well over +100% (after inflation) during this decade.
- In addition, despite the disastrous returns to stocks, treasuries, corporates, and housing – energy and precious metals performed well, e.g.: Oil (+72%) and Silver (+23%) after adjustment for inflation.
Eleven Decades.Opportunity has always existed. If one restricts the timeframe to individual decades, then strong performers included (all returns are after inflation):
2000s Silver +368%
1990s Consumer disposable stocks (e.g., Colgate-Palmolive +879%)
1980s Sweden stocks +719%
1970s Gold +704%
1960s Australia stocks +189%
1950s Japan stocks +1282%
1940s US transportation stocks +64%
1930s Finland stocks +171% or German 10-year treasury bonds +324%
1920s US utility stocks +654%
1910s Standard Oil Company breakup >>+100%
1900s Australia stocks +182%
One could react to the asset categories appearing in this table by claiming that they either could not or would not of invested in such areas in the decades indicated. Such an observation fundamentally misses the point. What is important is that the opportunities did exist, they were the result of secular drivers, and investors somewhere successfully harvested them.
None of these returns was accidental. Each was driven by long-lasting, episodic drivers – where timing was irrelevant and only participation mattered. The approach to asset allocation that asks the question“What are the drivers behind the current secular/episodic era and what asset classes will be favored and which will be disadvantaged?” is not a new investment-decision process. Quite the opposite, it dates back to the 1940s with the inception of the institutional hedge fund industry, which popularized “global macro,” an approach that seeks out opportunities for which timing is virtually irrelevant.
Return data for global macro hedge funds does not go back to the 1940s, but quality returns do exist since the mid-1980s. For the period 12/31/1986 through 11/01/2012:
- Global macro hedge funds  have returned 14.1% per annum versus
- 8.7% for AAA-rated corporate bonds,
- 7.5% for 10-year US treasuries,
- 4.1% for commodities (CRB Index), or
- 9.5% for the S&P 500.
Bountiful investment opportunities have always existed and probably always will. But success will require an approach other than the poorly performing Buy&Hold or the excessively fragile Market Timing. An approach that asks and answers the question “What long-duration forces are at play and which asset categories hold opportunity or peril?” dovetails well with this reality.