It’s been about a year since the stock market fell off the cliff and every strategy seemed to go bad. Can we finally put that to rest and go back to modeling?
The late-2008 stock-market collapse was pretty bad, especially last October. We all know that. But even more frustrating, imagining that anything can be more frustrating than the vigor of the decline, was the way supposedly prudent strategies failed to help investors mitigate the collapse.
Figure 1 shows the result of a 3/30/01-present performance test of a Portfolio123 Value model (combining a screen and then selecting the top 25 stocks as per a balanced fundamentals ranking system).
click to enlarge
It illustrates how bad late-‘08 was even for a strategy one might regard as conservative.
It’s tempting to wonder about the details of this particular value strategy and whether the more defensive performance we’d wish for could have been achieved had our model been “better.” Actually, though, the particulars are almost irrelevant since Figure 1 looks pretty much like what we got in late-2008 from just about all strategies, growth, value, fundamental quality, sentiment, momentum; you name it, Figure 1 more or less shows it. Nothing at all seemed to work. Now that’s frustrating!
It wasn’t this way during the collapse we experienced in the early 2000s. Back then, the market was much more willing, so to speak, to recognize supposedly reasonable strategies. Figure 2 shows how this particular model performed back then.
The strategy had its bad moments, but on the whole, it outperformed the S&P 500 with plenty of room to spare.
So where does that leave us now? Have we entered into a new dark-age in which the market will no longer reward good strategies or punish bad ones? Outperforming on the downside is certainly not nirvana. But it’s a heck of a lot more tolerable than the blast-everything mess we were experiencing a year ago.
It’s still far too early to give definitive answers. But early indications suggest the market is in the process of elbowing its way out of the strategic cave.
Let’s start with Figure 3, which provides a close-up of how this same value strategy performed since the recent market trough.
It wasn’t spectacular, but it did beat the S&P 500 and certainly does enough to raise hopes that a “better” model might provide more reward.
Figure 4 below, which looks at a multiplicity of strategies, adds to the sense of 2008 being an aberration from which we’re in the process of moving away. It summarizes the performance of the PowerShares Dynamic ETFs, the ones that attracted notoriety by using proprietary indexes compiled using fundamental rules designed to outperform standard benchmarks. This is a hodge-podge of different strategies, some of which would be expected to work at a particular point in time and some of which should be expected to falter. The average return is not important for our inquiry. What we’re interested in right now is the standard deviation, the measure of how widely varied the individual observations are.
The key takeaway from 2008 is not so much the horrible return but the narrowness of the standard deviation, particularly standard deviation as a percent of return. 2009 is likewise narrow, but at least it’s wider than it was in 2008. That’s consistent with the idea that the market is trying once again to distinguish among strategies, rewarding some and punishing others.
Figure 5 provides a slightly different perspective. It examines the iShares style-oriented index funds. These funds don’t claim to try to outperform anything, but they do slice and dice established indexes like the S&P 500 into style (growth versus value), and size categories. There are also some “core” offerings that blend everything. If the market is treating some strategies differently than others, we should see some noteworthy standard deviations here as well.
Indeed, we do see a very narrow standard deviation in 2008 and a wider one so far in 2009.
So where does that leave us now? Can we calmly go back to modeling and invest happily ever after? Or must we still worry about the ghost of 2008?
There are really two separate issues here.
One is the state of the economy. Are we really poised for recovery, or is the good news that’s been propelling the market just a cruel illusion? Many have spoken or written on the topic expressing a wide variety of opinions. Speaking for myself, I’m still in the I-don’t-know stage, leaning a bit toward the positive side of the fence.
Today, though, I’m more concerned with the second issue. Has the market returned to a state wherein some strategies work and others don’t? It appears to be in the process of doing that. This doesn’t mean the sort of stylistic convergence we saw in 2008 won’t recur. But it does seem that ’08 was unusual and that it took one heck of a crisis to get the market to simply dump everything, style be damned. It seems reasonable to assume it would take a comparable extreme (crisis, or possibly something extremely good) to generate that sort of convergence.
Disclosure: No Positions