In our last post on valuation, we looked at whether Apple’s historical mutiples could help predict future returns. The notion was that since historic price multiples (e.g., price-to-earnings) reflect the market’s value of the company, when the multiple is low, Apple’s stock is cheap, so buying it then should produce attractive returns. However, even though the relationship between multiples and returns was significant over different time horizons, its explanatory power was pretty low.
Stock analysts are usually separated into two philosophical camps: fundamental or technical. The fundamental analyst uses financial statements, economic forecasts, industry knowledge, and valuation to guide his or her investment process. The technical analyst uses prices, charts, and a whole host of “indicators”. In reality, few stock analysts are purely fundamental or technical, usually blending a combination of the tools based on temperament, experience, and past success. Nonetheless, at the end of the day, the fundamental analyst remains most concerned with valuation, while the technical focuses on price action.
In a previous post we compared the results from employing a 200-day moving average tactical allocation strategy to a simple buy-and-hold investment in the S&P500. Over the total period, the 200-day produced a higher cumulative return as well as better risk-adjusted returns. However, those metrics did erode over time until performance was essentially in line or worse since 1990.
While there’s still some more work to do on understanding the drivers of performance for the 200-day strategy.
Don’t hold your breath. We’re taking a break from our deep dive into diversification. We know how you couldn’t wait for the next installment. But we thought we should revisit our previous post on investing strategies to mix things up a bit. Recall we investigated whether employing a 200-day moving average tactical allocation would improve our risk-return proflie vs. simply holding a large cap index like the S&P500.
What we learned when we calculated rolling twenty-year cumulative returns was that the moving average strategy outperformed the S&P 500 76% of the time.
“Diversify, diversify, diversify!” Mantra, call-to-arms, or warning. Whether you’re an amateur or professional, a student or professor, a pedestrian or pundit you’ve been told that diversification is patently good when it comes to investing. Golly, it makes sense. Don’t bet it all black. Don’t own just one stock. Even grandma knows this. After all, she told you not to put all your egss in one basket. Then again she also told you about the Easter Bunny, who did just that.
In our last post, we discussed the potential for adding a tactical trigger to execute a strategy. In this case, the strategy is investing in a large cap stock index that allows us achieve a compounded annual return of 7% and limits the yearly deviation of that return not to exceed 16%, essentially an index roughly in line with the S&P500. As we noted, there was a 54% chance we might not make our total return goal.
In our last post, we defined the goal of an investment strategy, showed how comparing strategies may not be as straightforward as one would imagine, and outlined some critical questions that need to be answered when weighing competing strategies. In this post, we’ll look at what an investment strategy’s main constraints — namely, return and risk — actually imply.
What do the numbers say?
Assume you’ve chosen the strategy and assume it’s simple: invest in a large index of stocks, namely the S&P500.
Motivation
This string of posts is meant to help non-professional investors understand some of the complexities involved in choosing an investment strategy, suggest a logical framework on how to do just that, and offer different ways to analyze the data that motivate the strategies we’ll examine.
Strategies for the long run
Investment strategies and styles abound — from fundamental to quantitative to technical. For the professional investor how much credence one gives to each approach depends as much on education, training, and employer as on open-mindedness and opportunity cost.