Back To The Future?

Source: Shiller Data, JQR Capital

The Market Portfolio

Last week we compared the venerable 60/40 stock/bond portfolio to the historical performance of a calculated market portfolio (MP) over the past 40 years. This was our first comparison between a strategic asset allocation approach (60/40) compared to a tactical asset allocation (MP) approach. It turns out that our suspicion proved correct that the tactical approach provided a slight higher risk-adjusted return over the 1983 to 2022 period. The respective Sharpe ratios (0.548 versus 0.564) indicates a slightly smoother “ride” using the tactical approach. 


Source: FRED Data, JQR Capital

Back To The Future 

We now start looking further back than 1982 by including data from Yale University Professor Robert J. Shiller. His data goes all the way back to 1871 and it is the basis of his famed cyclically adjusted price to earnings (CAPE) ratio. The reason for our literal backtrack is that sometimes we need to go backwards before we go forwards - with conviction.


Source: Shiller Data, JQR Capital


This chart shows that during the past 148 years, the overall returns from 10-year US Treasury bonds and large capitalization US stocks have been quite similar. The overall path taken by the bond value (Vb) has been a much smoother ride for investors than that “enjoyed” by the stockholders (Vs). The very recent (think last 15 years) downturn in the bond trajectory is due to the surge in bond yields from historic lows. We recall that bond prices move in opposite directions to the bond yields.

Earnings Drive Prices

One of the key reasons for using Professor Shiller’s data is that it includes an important fundamental ingredient - namely corporate earnings - that is not readily available in other data sets. Corporate earnings are most often defined by annualized net profit. It may be obvious, but the reason to be in business as a for-profit entity is to (drumroll please) earn a profit. One of the valuable lessons from my business school education is that the main goal for corporate managers is to maximize profit to the firm. These profits should then maximize wealth for the shareholders - who happen to own the entity.


Source: Shiller Data, JQR Capital


The chart shown above highlights the general trend that earnings drive prices over a long period of time. There have been dips and disconnects, but the general thesis seems plausible. Next time we will dive deeper into the Shiller data and present at least one method of asset price prediction. Please stay tuned!

 

If one does not know to which port one is sailing, no wind is favorable. - Lucius Annaeus Seneca


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Disclaimer

Past performance is no guarantee of future results. Any investment involves some amount of risk and may not be suitable for all — or any — individuals. You should consult with your investment advisor before acting on this — or any — financial information.

References

http://www.econ.yale.edu/~shiller/data.htm

https://www.jqrcapital.com/channels/blog

https://www.brainyquote.com/


Copyright © 2024 JQR Capital Management, LLC
Location: 23 Foxridge Rd, West Hartford, CT 06107, USA

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