| Cliff Asness, the co-founder and chief investment officer of AQR Capital Management, calls it "The Idiot Strategy." At the recent Grant's Spring Investment Conference in Manhattan, he explained it this way:
Buy what's been going up best over the last year. Sell what's been going down
over the last year... The winners tend to keep winning and the losers tend to
keep losing.
Asness uses the idiot strategy for a small portion of the assets under his care. Most people - at least those who care about the price they pay - would shy away from buying something that has gone up a lot. But it can work.
In fact, lots of weird things work in the stock market. For example, take the old advice, "Sell in May and go away." It actually works, assuming you don't forget to get back into the market on November 1.
During the last 60 years, if you had invested in the S&P 500 from November 1 to April 30 every year, then sold out on May 1 and put your money in T-bills until November 1, you'd have earned 11.1% per year. On the other hand, if you had invested only from May 1 to October 31 each year, your annualized return would've been just 4.7%!
What's really weird about this "May effect" is that it works in other markets as well. Researchers Sven Bouman and Ben Jacobsen found it worked in 36 of the 37 countries they studied.
The truth is that markets can be wonderfully counterintuitive places. You hear all kinds of advice that sounds sensible. Then you run the numbers and find that you should do the opposite.
Take the idea that you want emerging market exposure because those economies are growing faster and, thus, you'll earn better returns than if you invest only in the good old US of A.
At first blush, this idea seems obvious. Too bad it isn't true. Since 1900, emerging market returns have trailed behind developed market returns.  Now, there are all kinds of debates about what country to include in which category and when. Some indexes absurdly include South Korea, for example, as an emerging market. Others don't. Some have Greece as developed. Others have it as an emerging market.
The above chart uses a GDP rule and counts only the richest countries as developed. (All the usual suspects - chiefly the U.S. and Western Europe, etc. - are the developed markets). These markets did better overall than their emerging counterparts.
If you think about it, it's not hard to understand why. Russia's stock market went to zero after the Bolsheviks took over in 1917. China's markets went to zero in 1949 after the communist revolution. These are the big examples, but people forget how easy it is to put up a zero, or close to it, in an emerging market. (Romania went to zero. Poland went to zero. Hungary went to zero. There are others.)
When people use more recent data, they get great numbers. During the last decade, for example, the MSCI Emerging Market Index has produced double the return of the S&P 500 Index. But these short-term numbers are deceiving as far as being predictive of what might happen next. If anything, they grossly overstate the potential of emerging markets. As Steve Bregman at Horizon Kinetics recently pointed out,
In the case of Russia and China, the data can only go back two decades or so.
Those are two major emerging markets. Furthermore, the initial data can be
very misleading, because how did any of these companies come into the
marketplace? The government owned everything. It basically auctioned off
assets and had no idea at what prices to do so (or perhaps set the prices
deliberately low so as to advantage those few buyers with the political and
financing access to bid for the shares). The fact that investors earned a very
high rate of return in the early years resulted from very unusual circumstances.
And because the measurement period is so short, those unusual circumstances
still weigh very heavily upon any index results.
The other thing Bregman warns about is that emerging markets can be narrow. Meaning that there aren't that many listed companies, and one big company can distort the returns of that country's index.
Furthermore, it turns out that the best stock market returns often come from investing in the slowest-growing economies.
Once again, I turn to Dimson et al., who write in their yearbook:
Contrary to many people's intuition, investing in the countries that have recently
experienced the lowest economic growth leads to the highest returns - an
annualized return of 28% compared with just under 14% for the highest GDP
growth quintile.
Mongolia is a great recent example. The country's economy is growing by double-digit percentages. Yet pretty much everybody who has invested in Mongolia in the last couple of years has lost money. You'd have been better off in Greece, where the economy has been contracting, but where the equity market has doubled during the last two years.
When you think about this phenomenon, it kind of makes sense because it comes down to price - specifically buying low and selling high. The GDP data is backward-looking. The market knew Greece was imploding well before the GDP figures came out. So asset prices adjusted and came way down. This washout laid a good base for outstanding returns for the investors who got in at that point.
Conversely, expectations were high in Mongolia, and when they slipped even just a little bit, the market prices reacted more violently. (Now, though, would seem a good time to stay in, as expectations are pretty low.)
Anyway, that's my brain food for you today. Just remember the market is full of puzzles and counterintuitive insights. Don't be quick to fall for your own prejudices about what makes stocks go.
Good investing,
Chris Mayer
for Free Market Café A Note from Eric: Tactics like "The Idiot Strategy" and "Sell in May and go away" are helpful at the margin, or in the absence of a better idea. But the real money is made from buying great companies at good prices... and that's exactly the strategy that has enabled Chris Mayer's investment letter, Capital & Crisis, to deliver winning stock ideas for more than a decade. Learn more about Capital & Crisis here. | |
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