The Top 5 Contrarian Reads of the Week
For all that is written on the topic, the key to beating the market can be boiled down to a single concept: variant perception. In order to earn a return that's different from the market average, you need to do different things, based on views that differ from the consensus. Here are some of the best contrarian articles I read this week.
Are we there yet?
In an opinion piece published on the Financial Times website, Edward Chancellor, strategist at asset-allocation investor GMO (and the author of the first-rate book Devil Take the Hindmost: A History of Financial Speculation), cites research concluding that the credit crisis may only have been the penultimate stage of a 50-year debt supercycle. As we move through the final stage -- a "government finance bubble" -- all is not well:
In the US, falling interest rates have been accompanied by a downward trend in nominal GDP growth. This may be a sign that credit has increasingly been put toward non-productive uses -- financing the construction of McMansions in the last decade and government welfare transfers today. US investment also remains on a downward trend. This means that as the stock of debt becomes ever larger, the future income streams necessary to repay the loans are set to shrink.
What are the implications of this analysis for investors? Chancellor's commentary is titled "The end may be nigh but don't bet on it" [free registration may be required]. He concludes, "In the investment world, to be early is to be wrong."
The end is not nigh
"The end of the global monetary system is not nigh," writes legendary bond investor Bill Gross of PIMCO in his February 2013 Commentary -- but that doesn't mean he isn't concerned. Instead of a "supercycle," Gross prefers the metaphor of a "credit supernova," in which [Gross' emphasis]:
...our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic -- it is running out of energy and time. When does money run out of time? The countdown begins when investable assets pose too much risk for too little return; when lenders desert credit markets for other alternatives such as cash or real assets.
Gross does have some specific recommendations for investing in this environment, including investing in "global equities with stable cash flows that should provide historically lower but relatively attractive returns."
And speaking of historically lower returns...
When government bonds offer zero or negative yields on an inflation-adjusted basis -- as they do now -- what are the implications for equities? The Economist's Buttonwood columnist looks at the impact of low interest rates [free registration may be required] based on historical data from this year's Credit Suisse Global Investment Returns Yearbook, which was published on Tuesday. Offering little solace to investors hoping to find refuge in stocks, he concludes:
Low real rates are associated with low future returns on equities; high real rates are associated with high future returns. ... The optimists would say that low rates are central banks' device for engineering a recovery; if so, that recovery does not show up in equity markets over as long a period as five years.
The full 2013 Credit Suisse Global Investment Returns Yearbook can be found here (link opens PDF), and it's well worth a look. Written by Elroy Dimson, Paul Marsh, and Mike Staunton ("DMS" hereafter) -- a trio of experts on worldwide asset returns from the London Business School -- the Yearbook sets the standard for thoughtful research for sell-side institutions.
Incidentally, the authors estimate that the average annual return from U.S. stocks over the next 20 to 30 years will be less than 4% after inflation. This is significantly below the 6.3% annualized return U.S. stocks delivered from 1900 to 2012. Two factors contribute to this. One, the current real yield on U.S. Treasury bills is negative, whereas it has historically been positive. Secondly, DMS adjusted the expected incremental return of stocks over risk-free assets downward relative to the historical figure in order to account for "non-repeatable factors that favored equities in the past."
To be clear: 3.5% is roughly what the S&P 500 is poised to deliver in the long term, and it's what investors can expect to earn from index funds such as the SPDR S&P 500 ETF and the Vanguard S&P 500 ETF . That's more than they can expect from the Russell 2000 ETF : Using a similar method to that of DMS, GMO estimates that small-cap stocks will earn an average real return of minus 0.8% over the next seven years.
Being contrarian: Does it pay?
Is there any point to being contrarian? Dimson, Marsh, and Staunton suggest that stock market performance does exhibit some degree of predictability, which investors can harvest:
Investors should take advantage of opportunities when returns are expected to be higher, and hence should buy when prices are low relative to fundamentals. In historical terms, that means buying enthusiastically during the October 1987 crash, during the Lehman crisis, and during other major setbacks; and selling outperforming assets during the 1990s bull market.
Easier said than done, of course; they go on to say, "Following a contra-cyclical investment strategy, at the very time that investors are behaving pro-cyclically, is uncomfortable."
However you're positioned, I hope you enjoy a comfortable weekend all the same.
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The article The Top 5 Contrarian Reads of the Week originally appeared on Fool.com.Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him @longrunreturns. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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