Is There Anything to the 18-Year Theory?

by: Roger Nusbaum

Yesterday there was an article on Seeking Alpha with a fantastic title: With 3, 5, and 10 Year Stock Returns Negative, Why Are Pension Funds Assuming 8% Returns? I tweeted, "because they have to."

A chart of the US stock market for last 100 years shows that for big chunks of time the market goes up a lot and then there are big chunks of time where it takes a very bumpy ride to nowhere.

For people who don't want to be very active with their investing but who take the time to develop a basic understanding of it, the task can be made a little easier. Some people like to hone in on these cycles lasting 18 years and while that might be a little simplistic going forward the nature of the past cycles combined with the current fundamental backdrop argues for more bumpy round trip to nowhere trading for a few years.

The chart comes from Cam Hui who writes the Humble Student of the Market blog. I have unyielding faith there will be some sort of repeat of what the market did from 1944 until 1962 and then again from 1982 until 2000. Maybe it will start in 2018 and maybe it won't be as much is those two other periods but something similar will come.

The ideal way to navigate this would be some sort of strategy that deemphasizes equities in a period like 1966-1982. This could mean relatively heavy doses of ETFs like iShares COMEX Gold Trust (NYSEARCA:IAU), inflation protected products like the SPDR Barclays TIPS ETF (NYSEARCA:IPE) if things look inflationary or regular bond funds like the iShares Barclays 10-20 Year Treasury Bond Fund (NYSEARCA:TLH) in an environment that appears to be deflationary, like now. In addition to that some sort of absolute return product like the IndexIQ Hedge Macro Tracker ETF (NYSEARCA:MCRO). The big idea is to protect assets in an environment where equities do not do well.

Then, after 18 years one would ideally rotate into some sort of aggressive equity exposure to capture a likely five-bagger, or more, in the market.

I use the word "ideal" because perfect execution would require perfect information and that is of course unlikely. This could be partially mitigated by simply reducing equity exposure after 15-20 years of raging bull market as opposed to eliminating it. Something like the PowerShares BuyWrite Portfolio (NYSEARCA:PBP) which some clients own could be one way to do this. I would also add that after 15-20 years of bumpy round trip to nowhere anyone on this sort of path should start increasing equity exposure.

This is a vague but evolving thought but I believe it is best suited to people who are willing to spend only some time on their investments as opposed to no time or a lot of time. As I have pointed out numerous times despite the fact that the S&P 500 was down 24% price-wise in the recently ended decade many easily accessible countries thrived. Mexico was up 345%, Brazil up 301%, India up 243%, Norway up 121% and Israel up 109% as some examples.

This is not to say that those countries will continue to perform like that if the cycle continues in the US until 2018 but some countries will (maybe those, maybe others) and for people willing to do a lot of work the notion of hiding as outlined above becomes less relevant.

The relevance of the first line of the post is that, as a do it yourselfer, if you save properly you are better positioned to take what the market gives. Many pensions obviously were not able to average 8% per year in the last decade and some did far worse by chasing heat or putting too much in private investments that blew up. If markets can recover from the Great Depression they can recover from the current event. The only variable will be time. You can hide out, which is perfectly valid, or you can take the time to find healthier countries, and obviously ETFs, to own.