Academic studies repeatedly show that asset allocation has a far greater impact on your investment success than stock picking skill or market timing. Good stock picking is not as important as you think. Even the best stock pickers suffered heavy losses during the bear market of 2008/9 while the average stock picker enjoyed huge returns in the post March 2009 market rally. The key to success is being in the right place at the right time. Therefore, you need to carefully consider what level of exposure you should have to the various asset classes. Let’s review the prospects for two of the main asset classes – bonds and stocks.
As I write, bonds are very popular with investors and long-dated government bonds of countries considered good credit risks have had a great run. These bonds have enjoyed a bull market since 1981. Consider the yield (July 2012) on ten-year bonds of the following countries:
Switzerland 0.5 per cent
Japan 0.8 per cent
Germany 1.2 per cent
United States 1.5 per cent
These yields are at historic lows mainly because there has been a flight of capital into these perceived safe bonds due to the ongoing uncertainty in world financial markets. These bonds currently offer a negative real return as inflation rates are running above these levels. It is interesting to note over the last century, that US inflation rates have averaged over three per cent and US ten-year bond yields have averaged over 4.5 per cent. If US bond yields were to return to these more normal levels, the price of these bonds would fall significantly.
Stocks have been in a secular bear market since 2000 and although they have moved up and down they have basically gone sideways over this 12-year period. This has been very disappointing for investors but the good news is that secular bear markets are invariably followed by secular bull markets. The last secular bull ran from 1982 to 1999 and the average annual gains recorded on US markets were over 15 per cent. So how long do we have to wait for the good times ? Let’s look at the history of secular bear markets:
Period No. of years
1802 – 1815 13
1835 – 1843 8
1853 – 1861 8
1881 – 1896 15
1906 – 1921 15
1929 – 1949 20
1966 – 1982 16
2000 – ?
If you eliminate the outliers of eight and 20 years you are left with secular bear markets ranging from 13 to 16 years. On this basis one could expect that sometime in the next four years a new secular bull market will unfold.
Looking to the future , those with a long term perspective should overweight stocks. Stocks are cheap by historical standards and the current uncertainties which are weighing on prices will pass. Remember the markets have survived many uncertainties including two World Wars and the threat of nuclear war. You may have to wait awhile for the good times but the current uncertainties provide you with an opportunity to load up on cheap stocks but few will take this opportunity.
Warren Buffett once remarked, ‘When hamburgers go down in price we sing the hallelujah chorus in the Buffett household. When hamburgers go up, we weep. For most people, it’s the same for everything in life they will be buying…except stocks. When stocks go down and you get more for your money, people don’t like them any more.’