Q: The performance turn since late January has been dramatic. Is this a bounce, or the beginning of a sustained move?
Arnott: Probably the latter. Since January’s lows through April 30th, our All Asset strategies returned over 14.5%, outpacing U.S. 60/40 (60% S&P 500 Index, 40% Barclays U.S. Aggregate Index) by more than 650 basis points. Is this a “dead cat’s bounce” or the start of a multi-year bull market? While it’s entirely possible that we will see a test of the lows, it’s also entirely possible that we will not test these lows. As we said in April’s Insights, we have neither the clairvoyant ability to time market turns, nor the skill to predict the catalysts for a bull market top or a bear market bottom. Instead of pointing to whether we’ve seen the bottom for the Third Pillar or the top for mainstream 60/40, we prefer to focus on long-term future rates of return.
While the last several weeks’ performance of the Third Pillar has been encouraging, it’s human nature to use the recent past as an anchor to form our expectations.1 Whether we are using the recent bounce to shape our optimism, or the grinding three-year bear market in Third Pillar assets to shape our pessimism, extrapolating from the past is profoundly unwise. It’s the single greatest source of investor error. For decades investors have made a mistake by setting unrealistic expectations based on inflated historical returns. So, when assessing the Third Pillar’s forward-looking prospects after a short-but-impressive run, we ask ourselves: Is the Third Pillar still trading at cheap levels relative to history? Or, has the recent strong performance put a dent on its forward-looking return prospects? Both are true.
The good news is even after the recent rebound, the Third Pillar is still trading at attractive levels relative to its history. It’s gone from cheap to a bit less cheap. The latest run doesn’t make Third Pillar markets expensive or vulnerable. Case in point: our models for long-term (10-year) real returns suggest that the recent outperformance in Third Pillar markets clipped their collective real return prospects by less than 0.2% since December.2 This is hardly a blow. We believe that Third Pillar asset classes today, especially relative to expensive mainstream U.S. stock and bond markets, are still bargains boasting attractive multi-year return prospects.
Arnott On All Asset, May 2016
May 26, 2016
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