Attached is the latest from Niels Jensen at Absolute Return Partners. As always, it’s a very good read.
“Using U.S. market data going back to 1926, Vanguard analysed the predictive powers of a whole range of metrics. The rather depressing conclusion – at least from an economist’s point of view – is that we are pretty much wasting our time by assigning any value at all to what goes on in the real economy. Of all the metrics tested by Vanguard, only P/E ratios seem to explain some reasonable proportion of future (real) stock market returns, and that is only if you are prepared to take a very long term view (10 years in the Vanguard study).
I have been writing the Absolute Return Letter since October 2003. At least 75% (I haven’t checked) of all those letters have focused on various aspects of the macro economy and a great many of them have gone on to make predictions on stock prices, interest rates, commodity prices and currencies. Have I been wasting my and, more importantly, your time during all those years?
I don’t think so, but my answer does require some clarification. At Absolute Return Partners, when structuring portfolios for our clients, we distinguish between three different time horizons – the very near term (the next few months), the medium term (from a few months to a few years) and the long term (many years). Most mutual funds, pension funds and insurance companies allocate the majority of their capital to the medium term, making it a very crowded space and the more crowded the space, the more efficient it usually is, and the more difficult it will be to generate alpha.
The short term is often ruled by more aggressive investors. Hedge funds dominate this space, frequently at the expense of private investors. The long term is the least crowded; it is in fact distinctly un-crowded in the current environment. As I have repeatedly pointed out over the past couple of years, one of the most noticeable implications of the financial crisis is the craving for liquidity. This has driven more capital than ever before towards the short and medium term, creating very attractive opportunities for those investors who can take a long term view.
Despite the findings of Vanguard and others I maintain my long held view that it is possible to identify long term economic trends which are likely to have a quantifiable impact on asset prices; however, the effect is only measurable over the very long term. Now, we cannot construct portfolios with only the long term in mind. If we did that, we would almost certainly go out of business before our ideas came to fruition.”
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