I don’t discuss long-term investment strategies for various reasons, but I understand that the majority of investors don’t have the time to implement an approach that is similar to mine. I have, on occasion, made broader long-term prognostications. For example, in early 2009 it was very popular to proclaim that “buy and hold” was dead (which I said was nonsense at the time) or that the bear market was never going to end. The smart money was doing the opposite of what the permabears were saying as “once in a lifetime opportunities” were apparent in many markets.
It would be convenient revisionist history for me to say that I was “all in” on long-term bullish bets back in 2009 (that hasn’t been my M.O. over the last 5 years), but there are a few long-term indicators that I have routinely tracked in recent years that have proven to be superb long-term trend indicators. Among them are my Expectation Ratio, Stock market to GNP ratio, the AAII’s allocation portfolio and jobless claims trends. In late January 2009 I highlighted one very bullish long-term development in the markets:
“The indicator (my ER) has only just recently become positive again which is telling me that analysts are finally beginning to cut their estimates to realistic levels. The indicator was a little early to the party in 2007 and I presume it will be early again in forecasting a recovery, however, it is a good sign that now is a time when you might want to be dipping your toe in the waters. If you’re young and have a long time horizon you certainly want to be adding to positions.”
A few weeks later I discussed the long-term impact of jobless claims:
“The inverse of this is what we’re seeing now. People are being laid off at a record rate and that’s a potentially bullish sign. It means that the economy is entering a period of under-capacity. Although it goes against every intuition you might have I think this is one more sign (in addition to my ER) that we are closer to the bottom than the top. If you have a long time horizon I think it’s best to ignore those people who are saying that buy and hold is dead. In fact, as I’ve repeated recently, buy and hold is likely more viable now than ever.”
At the same time the stock market to GNP ratio was also giving a very bullish signal and the AAII’s small investor allocation for equities had declined to levels consistent with previous market bottoms. For those with a stomach for risk the stars were in many ways aligned. It’s safe to say that my own performance over the last two years would have been superior if I had been eating more of this long-term cooking, however, a longer perspective (my 60%+ outperformance in 2008 for instance) shows that my short-term tactical approach to the markets has saved me a great deal of anxiety and successfully resulted in high risk adjusted returns. Regardless of my current approach, it’s useful to update these long-term models on occasion if not for my own benefit then for the benefit of the reader. Maintaining a grasp on the overall macro picture can also be useful in trying to grasp where we are in the investment cycle.
Since I’ve updated the first three indicators just recently I figure it’s about time we update the fourth. The chart below shows the most recent jobless claims data. Any economist will tell you that job’s are likely the single most important component to economic and profit growth. The weekly jobless claims data remains the closest real-time proof of labor market trends. Therefore, equities tend to be relatively closely correlated with claims data.
I have (somewhat arbitrarily) used this indicator in recent years to gauge labor utilization. When claims are low it means the economy is humming and that things are unlikely to improve substantially. This tends to coincide with equity environments that are richly valued or overvalued. The opposite occurs when claims are high. This tends to coincide with an environment in which labor is being underutilized and equities are inexpensive. Over the last two years we’ve moved from a period that is consistent with aggressive equity accumulation (very high claims data) to a period of more moderate growth, but growth nonetheless. We’re still well off the historical range in which equities are a clear sell.
If we look at all four indicators the outlook remains a bit mixed. My ER is very bullish. The market:GNP ratio is moderately overvalued. The AAII allocation survey is not consistent with market tops. And finally, the jobless claims data is consistent with an environment in which you want to own stocks, but not aggressively accumulate stocks. This all adds up to a longer-term outlook of moderate, but not aggressive bullishness.
So, the question then is – if you held a gun to my head would I be a long-term buyer or seller of stocks currently? I would likely be a buyer, however, because I still believe we are in a balance sheet recession and have resolved none of our long-term imbalances I am not eating that cooking. Instead, I continue to use a short-term model based on the idea that the secular bear is alive and well and volatility must be navigated as opposed to ignored. Risk management is not going out of style. While a long-term outlook is likely to reward equity investors in the coming years I believe higher risk adjusted returns can be obtained through a multi-strategy short-term approach that focuses on hedging strategies and risk management. Hopefully, however, this helps some of you long-term investors put things into perspective.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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