Tuesday, September 13, 2011

Buy, hold, regret

IT IS a truth universally acknowledged that equities outperform over the long term, so that the best strategy is to buy and hold. But as Deutsche Bank's long-term asset study (the subject of yesterday's post) makes clear, this has not been true for all markets. Over the last 50 years, the real returns from equities have been lower than those from bonds in Germany, Japan and Italy. In the Italian case, the gap is almost three percentage points, and that is despite the recent bond sell-off (actually, as Deutsche points out, a 5-6% yield on Italian debt is quite low by historical standards.)
The buy and hold mantra was developed in the US where real equity returns have generally been positive over long periods. But the US was history's winner in the 20th century; enjoying 100 years of political stability while its European rivals destroyed themselves in two world wars and Russia followed the dead end path of communism. The US equity market, in other words, displays distinct survivorship bias. In turn, that bias leads to greater confidence and thus higher valuations; eventually the valuations become so high (as in 2000) that they doom future returns to be disappointing.
Indeed, there is nothing so catastrophic for an asset class as the conviction that its price can only go up. It was the belief that borrowing to buy an house was "free money" - a source of income that beat working for a living - that helped fuel the subprime bubble. The mantra was that US house prices never fell at the national level; it proved mistaken. A blind belief in "buy and hold" is a similar mistake.
Nor does Deutsche offer much comfort going forward. The likely real returns from equities over the next five years are -2.6% (annualised) or (more optimistically) 0.6% over 10 years. That is largely because profits and high relative to trend and will mean revert. Valuations are better than they were in 2000 but are still not cheap (speaking of which, I have been sent an attack on the Shiller p/e that I will address in a later post). The likely returns from 10-year Treasury bonds will be worse (-2% a year over 10 years) and one can also expect negative real returns from property, gold and commodities. Only in corporate bonds (particularly high-yield) is there scope for positive returns.
Of course, the alternative to buy and hold is to try to trade your way through the cycle, a very difficult process that by definition cannot be achieved by the average investor. But this is the inevitable hangover after the debt-fuelled party of 1982-2007.

No comments:

Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.