As we head into Spring 2015 with the model in a cash position, we look back at the model’s performance in 2014 and note it as a year of “underperformance” vs. the S&P 500 (as the model produced a return of 8% and the S&P500 benchmark produced 13.5% ). From time to time, it is possible for an occurrence, such as this, to happen and for us to react with skepticism, uncertainty, and doubt, especially when it involves our investments. We are “hard wired” and persuaded by societal cues into thinking in terms of “short term” results and we tend to define the equity market in terms of “winning” and “losing” ( we are much more sensitive to “losing”).
We are fortunate to have 9 decades of historical model performance with which to analyze and review past occurrences of when the model “underperformed” the S&P 500.
As we can see in table 1 and the chart above, these years of underperformance have happened occasionally and are evenly distributed over the sample with “consecutive” years of underperformance occurring in sporadic fashion.
Table 2 shows the ratio of outperforming vs. underperforming occurrences and cum % performance.
The stock market’s price is the discounted present value of it’s future earnings and the market can “overshoot” this present value for periods of time. During this part of the investment cycle, this “overpricing” can be caused by: 1) portfolio analysts’ upwardly adjusted revisions in earnings estimates and 2) investors’ optimism and “fear of missing out” as the market rises or has, in retrospect, produced many consecutive positive years returns. We must expect that these periods will exist and can expect to leave some “gains on the table” with the knowledge that we are accumulating and compounding assets over the “long term”. We can gain perspective by examining the “long term” performance statistics, and adjust our reactivity and concern accordingly .
We can also gain perspective by viewing, in a graphic sense, how much equity exposure towards historical market up moves or down moves has been realistically “captured” by the model in order to achieve portfolio alpha (in this presentation) : https://docs.google.com/presentation/d/10n7vUDLdvrcPncEVXWa0aMFTdtWkkRavSLczS34RsCk/edit?usp=sharing
Asset allocation since 01/20/15 = cash
Probability of allocation into TLT (iShares 20+ Year Treasury Bond ETF) on 7/13/15 = 5O%