We recognize the substantial survivorship bias in our survey, having personally survived most of these episodes ourselves! So, to be more comprehensive, we also plot other periods when these asset classes fell within their lowest decile of historical three-year rolling absolute returns.6 A similar pattern unfolds. A large majority, or 88%, of all observations (43 of 49) deliver a positive five-year return. The average five-year cumulative return across all observations is 80%, or approximately 12% a year, suggesting both the presence and strength of mean reversion.
How do the asset classes perform on a relative basis? Recall that the broken asset classes in our survey had mostly fallen short of the performance of the S&P 500 in the years leading up to the proclamation they were broken. In the subsequent three years, these asset classes surpassed the performance of US stocks on a cumulative basis by an average of 45%, or 13% a year. After five years, the cumulative excess return of REITS, commodities, small value stocks, and high-yield bonds versus the S&P 500 averaged 101%, or 15% a year. Over this five-year span, the four asset classes fared significantly better than US stocks, with cumulative excess returns ranging from 10% (high-yield bonds) to 158% (commodities).
The press is often quick to label asset classes broken. Rarely is this the case, although exceptions do exist. For instance, the German and Russian stock markets during World War I, Japanese and German stock markets during World War II, and the Egyptian stock market in the early 1950s all collapsed. The near-obliteration of a stock market has happened, but it is an extraordinary occurrence.
The epicentre of risk in a crash is the most likely to experience a lengthy Type-3 base formation following the big decline. However, even within the crashing sector, there will be companies that come through the crisis relatively unscathed. They most often show early relative strength and come to dominate in the following years. However, there will also be times when leaders underperform. That occurs most often when the weak sector convalesces. That’s when value propositions become compelling and even deeply troubled companies can do well for a while; not least because of the base effect of low prices.
Let’s look at some examples.Click HERE to subscribe to Fuller Treacy Money Back to top