Looking Harder for Equity Returns

Quite a few times I have mentioned my opinion that normal equity returns will continue to exist but we may have to look harder to find them.

Yesterday's post on Vietnam, which ties in with looking harder, got me to thinking about something that theoretically takes on relevance if looking harder turns out to be correct.

If we allow that normal means a 10% annualized average return, then in a simplistic world $100,000 invested on June 11, 2007 would be worth $235,794.76 on June 11, 2017.

What if, instead of putting $100,000 into a diversified portfolio one year ago you put it all into Potash Corp of Saskatchewan (POT)? Your 1368 shares would have been worth $301,726.08 based on yesterday's closing price, which is almost $70,000 more than you would have hoped to have nine years from now.

In this obviously extreme example, an argument could be made for selling the stock (paying the gain if held in a taxable account) and putting it in short-term money or otherwise taking no risk for the next nine years. Selling the POT after a year and a day, paying the 15% and then averaging 3% per year would leave the original $100,000 at $343,886.48 in June 2017 when last June your target for that time was originally $235,794.

Before anyone adds 1+1 and gets eleven, let me explain where I am going with this by way of yesterday's example with VOF.L. To recap, bought at $2.48, sold half in a few months at $4.73 and still have the other half now priced below $2.00.

If you accept the notion that finding normal equity returns will come about by looking in places that are less familiar to us, then you can conclude that less familiar must include some countries/groups/themes/asset classes that are more volatile than buying a combo of SPY/EFA/IWM for your equity exposure.

Relative to less familiar there is nothing out of the ordinary with the sort of move VOF.L had. A diversified portfolio that includes these sorts of things could easily have a couple of things that go up 50-100% in what seems like a short period of time. I'm gonna say if you own something that goes up 100% in three or four months you need to at least consider selling some or all of it.

The psychology of taking a short-term gain like this is, you just got a few year's worth of return in a few months, you were lucky, take the gain. The reality of this sort of thing is that big moves often go the other way when the momentum runs out of steam.

In hindsight, based on price, clearly, selling all of VOF.L would have been better. Too much sitting on things that go up 100% and then cut in half without any action prevents you from getting to where you need to be.

The point of this is that if normal returns are going to be more difficult to come by and you are willing to look for them in new (to you) places, you will probably need to reorient your thinking about holding on to things. Go ahead and buy with the intention of holding if you're inclined to think that way (and I am), but be willing to take a large gain when the market gives it to you. A 2% weight in something that doubles in a few months adds 200 basis points for the year, which is a lot if you are targeting a "normal" equity return.

To tie in the POT example, if you can add 200 basis points in the manner above you are a little bit ahead and do not need to rush back in to something else.

It is unlikely that a portfolio will be chock full of VOF.Ls but future success may require having a few of them. If so, then the thinking will need to expand/evolve.

Comments

[kowalski]

All you are saying, basically, is to expect returns to reverse to mean (short term), which is ok, but how to exploit this practically is not so obvious, because it tends to be easy to buy the bad stock and to sell the good stock. What if the one stock you sell after a 100% run up (short term) is the very stock that trades 10 times higher (long term)?!