Real Returns

This is an older post but I had a reader asking about a similar topic so I thought I would repost…

Here are some long term charts based on the data from Morningstar / Dimson Marsh Staunton.

Below are the best, middle, and worst case scenarios for the main asset classes of sixteen countries from 1900-2011.  All are real return series on a log graph (except the last one).

First, here are the best cases for returns on your cash.  This chart goes to show that leaving cash under your mattress is a slow bleed for a portfolio.  I excluded Germany after the first series as it dominates the worst case scenarios (in this case hyperinflation).


Best Case:  -2.30% per year

Middle:  -4.10%

Worst Case:  -100%



Next up is real returns for short term bills.

Best Case:  2.25% per year

Middle:  0.71%

Worst Case:  -3.63%

(Real Worst Case, Germany -100%)


Followed by the real returns for longer dated bonds.

Best Case:  3.04% per year

Middle:  1.40%

Worst Case:  -1.91%

(Real Worst Case, Germany -100%)


And finally, the real returns for equities.

Best Case: 7.43% per year

Middle:  4.60%

Worst Case:  2.00%

 (Real Worst Case, China, Russia -100%)

And the same chart presented non-log…


Intrinsic Value by Another Method

Good post by Thompson on another global value methodology, this time from the bottom up (via ValueWalk).


Broadening the Window – Aligning Indicators with Correct Holding Periods

One of the biggest problems with value is the time it takes to work itself out.  Over, and under valued securities and markets can stay stubbornly mispriced for years, or even decades.  My favorite grandaddy of all bubbles, Japan, took about 20 years to get back to normal valuation.  And even now the stock market is down 30% from all time real highs (including dividends).

One popular criticism of the valuation models that Hussman, Gray, Buffett, Shiller, Grantham, and Philbrick et all propose is that they tend to work over 5-15 years.  Many conclude that they are then worthless as most people are trading on shorter time frames etc.  It doesn’t matter if it is PE, CAPE, Tobin’s Q, dividend yield or mkt cap to GDP, most don’t work that great in the short term.

(Note:  Our Global Value paper introduces another element, and that is relative valuation, which was shown to work great on much shorter time frames.)

So what is a simple answer to this criticism?  Simple:  hold the position longer.

Below we set out to test a very simple system.  The goal is to have a maximum allocation at cheap secular lows, and a minimum allocation at secular, expensive highs.

We divide the portfolio into five buckets of 20% each.  Each bucket can be anywhere from 0-100% invested in stocks, and the remainder is in 10 year bonds.  Therefore, the entire portfolio can be 0-100% invested in stocks or bonds.


Each year only update one bucket.  

If CAPE < 10, 100% of that bucket is in stocks. 0% in bonds.  Hold that position for 5 years.

If CAPE < 15, 75% of that bucket is in stocks.  25% in bonds.  Hold that position for 5 years.

If CAPE < 20, 50% of that bucket is in stocks.  50% in bonds.  Hold that position for 5 years.

If CAPE < 25, 25% of that bucket is in stocks.  75% in bonds.  Hold that position for 5 years.

If CAPE > 30, 0% of that bucket is in stocks.  100% in bonds.  Hold that position for 5 years.

Next year, repeat with the next bucket, so that each year you are updating just 20% of the portfolio (talk about lazy portfolios!)

(Note:  These cutoffs and % were picked out of a hat.  I’m sure there are better parameters, such as holding for 7-10 years.)

This way you have a portfolio that matches the holding period with the intended indicator horizon.  More importantly, how does it work?  (CAPE is the above strategy, not the CAPE strategy from the paper. 10 SMA is the moving average model from our QTAA paper.  )

Not bad – nice reductions in volatility and drawdowns.  I’m sure you could tweak the parameters with longer holding periods as well as better CAPE cutoffs, as well as even potentially using leverage and shorting.  Even better would be to use all of the global markets instead of just one.

Will try and write up in a longer paper at some point…readers, feel free to play around with the Shiller data on your own and report back!  



timing cape 

Before the Boom

Nice white paper from SEI and ETF Trends


Romick and Davis

A couple fun interviews, first Ned Davis and Ritholtz, then Forbes and Romick.



Becoming Asset Class Agnostic, or, A Golden Dilemma

People often get attached to their investments.  You will hear people described as a goldbug, or a stock guy, or perhaps a dividend income loving retiree.  I’ve never really seen the wisdom in falling in love with one asset class or another.  It seems to me from history that every asset class is great sometimes, and horrible other times.  On top of this layer in all the behavioral biases that people have once they like and/or own an asset class and you then start to really get emotions involved.

Lots of debate and inquiry raging about the shiny metals lately.  We have written about a lot of the fundamentals behind investing in metals on the blog in the archives, as well as some simple technical posts.  Here is one from 2009.  Here is a recent Hulbert piece on gold that summarizes this Erb and Harvey paper out recently: “The Golden Dilemma“.  From the Hulbert summary:  

“But to come up with an estimate of gold’s fair value, they calculate a ratio of gold to inflation going back as far as they were able to obtain data. They report that this ratio, when expressed in terms of the U.S. Consumer Price Index, has averaged about 3.2-to-1. Even at $1,400 an ounce, this ratio stands at 6.03-to-1, or nearly double this average.”

I thought I would update the chart in our earlier post, that simply looks at a long term trendfollowing approach to gold, and investing the cash in Tbills or 10 Year Bonds when below the long term trend as defined by 10 month SMA.  You would have exited the long gold position at the end of 2012.  This data doesn’t include March…


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The Golden Dilemma

Claude B. Erb

Campbell R. Harvey 

Duke University – Fuqua School of Business; National Bureau of Economic Research (NBER)

April 15, 2013


Gold objects have existed for thousands of years but for many investors gold has only recently become a tradable investment opportunity. Gold has been described as an inflation hedge, a “golden constant”, with a long run real return of zero. Yet over 1, 5, 10, 15 and 20 year investment horizons the variation in the nominal and real returns of gold has not been driven by realized inflation. The real price of gold is currently high compared to history. In the past, when the real price of gold was above average, subsequent real gold returns have been below average. Given this situation is it time to explore “this time is different” rationalizations? We show that new mined supply is surprisingly unresponsive to prices. In addition, authoritative estimates suggest that about three quarters of the achievable world supply of gold has already been mined. On the demand side, we focus on the official gold holdings of many countries. If prominent emerging markets increase their gold holdings to average per capita or per GDP holdings of developed countries, the real price of gold may rise even further from today’s elevated levels. As a result investors in gold face a daunting dilemma: 1) embrace a view that “those who cannot remember the past are condemned to repeat it”, there is a “golden constant” and the purchasing power of gold is likely to fall or 2) embrace a view that “this time is different” and the “golden constant” is dead.

Noteworthy for Two Reasons

iShares and an AZ pension fund are teaming up.  First, since iShares is launching their first active funds.  But more importantly, a real money fund is basically launching their own ETFs.  I am surprised this hasn’t happened sooner.  If I was a family office that pursued active management, why wouldn’t I just launch my own ETF to optimize my tax exposure?


Hussman Speech from Wine Country

Even though I left (and later sold) my car in Paso Robles on the way up, it was worth it to connect with some friends in Sonoma.  Here is a link to the presentations from a number of speakers, and I’ll link to the videos as they come online.  Highly recommend going next year! 

 “If you like and appreciate hearing from these speakers, please consider making a donation to further ALS research and/or please plan on attending our 2014 Wine Country Conference in April 2014 where we will be raising money for Autism. You can enter your email address in the sidebar to receive periodic updates about the 2014 event.”


Another $10k Winner

Glad to hear that another blog reader won another big prize this year, the $10k Wagner Award.  Going to download it and the other interesting papers from the NAAIM website (they also have a conference coming up in Denver).:


Click here to view and download all submitted Wagner Award papers from 2009, 2010, 2011, 2012

Download a copy of all of the 2013 papers including the prize winning paper:


Quant Approach to TAA Paper Updated

I updated our 2006 paper “A Quantitative Approach to Tactical Asset Allocation”.  I am going to send it to The Idea  Farm list this Friday so make sure to signup!




This 70 page new update includes:

1.  Results are extended out-of-sample to include the years 2009-2012.

2.  Additional asset classes are included (from 5 to 13).

3.  Alternative cash management strategies are included.

4.  Additional conservative and aggressive approaches are included.

5.  Alternative allocations are included.

6.  FAQ Section with answers to over 20 common questions.

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