I’m a sucker for contrarian indicators. The market has an entertaining, if infuriating, habit of proving everyone wrong at exactly the point at which it will cost the most people the most money.
Keeping an eye out for potential turning points can be a useful layer to add to your asset allocation decisions.
So I’ve just been enjoying reading an interesting new paper from Research Affiliates which points out that when an asset class is declared “broken”, it’s often a good sign that it’s about to pull a Lazarus.
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People are very quick to turn against a losing asset class
John West and Amie Ko of asset manager Research Affiliates have put out a paper looking at the historical performance of a selection of asset classes which have, at one point or another, been declared “dead” or “broken” by popular decree.
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As with most such studies, it's based on anecdotal examples. There aren’t many easy scientific ways to work out just how empirically “dead” an asset class is deemed to be.
But even with the caveat that the data is anecdotal and limited, it’s a useful reminder that the people who make these sweeping declarations are usually ignorant of history. It’s also a useful reminder that when you hear these declarations being made, it often suggests that the hard times are close to an end for said asset class.
Among other examples, the pair cite Business Week’s infamous cover story “The death of equities”, which was published in 1979, three years before one of the best and longest bull markets ever seen in US equities kicked off.
They also look at the late 1990s dismissal of real-estate investment trusts by US financial paper Barron’s, and the even more infamous 1999 claim by The Economist that dirt cheap oil was “likely to remain so” (that particular cover story marked a low for oil, pretty much to the day).
So what did they find? Long story short, the asset classes being condemned had all endured notably weak performance for at least three years, prior to being declared “broken”. They also tended to have strikingly underperformed the US S&P 500, which is arguably the most pertinent benchmark (ie, the one that everyone watches).
And yet, in the five years subsequent to being considered “uninvestable”, each asset class “roared back in a strong, and for many, swift rebound”. And the reality is, the periods of underperformance that led to the asset being condemned in the first place, were not unprecedented – they’d all seen similarly poor periods before.
West and Ko confirmed this pattern by looking to previous periods when the asset classes in question had endured particularly bad three-year underperformance and they found the same thing. In the vast majority of cases (nearly 90%) a terrible three-year period was followed by a strong five-year period.
Here’s a cheap and hated asset class for you
What does this mean for investors? It’s really just a reiteration of our regular advice – if you’re a long-term investor, it's better to buy stuff when it’s cheap and own less of it when it’s expensive. And try not to chase winners – it often ends badly.
Of course, the exasperating thing about all of this is that none of us knows for sure when struggling assets will turn around, and that makes them hard to hold on to. And there are always occasional exceptions. Entire asset classes have been destroyed, though it's pretty much always due to war (property destruction) or revolution (property confiscation).
I’ve regularly highlighted indicators that can be helpful on the sentiment front. I wrote about the global fund manager survey earlier this week, and I’ve talked about magazine and newspaper covers frequently in the past.
I’ve found the latter to be particularly helpful in terms of getting a sense of when the mood might be close to over-reacting. (Indeed, as I flagged up on Twitter at the time, The Times newspaper carried a strikingly stark front cover on 17 March this year, less than a week ahead of the market bottoming out on 23 March).
But nothing is infallible, and you can’t plan your entire portfolio around trying to time the market based on sentiment indicators.
For example, while I’m not convinced that the value versus growth distinction is a terribly helpful one (it’s somewhat vague), it's certainly true that value as it’s currently widely defined has underperformed growth for a long time, despite endless predictions of a comeback.
The point is more this: when someone says that an entire asset class is “dead”, that’s quite an extravagant statement. It’s almost certainly wrong. What it tells you instead is that this asset class is in the gutter.
If it’s in the gutter, it’s cheap. If it’s not going to die, then at some point it’s likely to revert to the mean. And if you buy it when it’s cheap, that means that you will get better-than-expected returns – if and when it does return to the mean.
These days, a notably disliked asset class is emerging markets. As I’ve just pointed out, the fact that it’s cheap and hated doesn’t mean you should put your entire portfolio into it. You should always be sensibly diversified, the nature of which is mostly dictated by your investment time horizon. But you should certainly have a bit of exposure.
My colleague Cris Sholto Heaton looked at some of the best ways to do so in a recent issue of MoneyWeek magazine. If you’re not already a subscriber, then don’t miss our future articles on the topic – you can get your first six issues free here.
(By the way, if you’re interested in contrarian investing and indicators, I think you’ll enjoy my book, The Sceptical Investor.)
