Understanding asymmetric points to buy and sell risk isn’t difficult if you have a common-sense market cycle framework. There are really only a few factors that need to go into one’s decision matrix as to how to position a portfolio between the risk-free –> risky asset spectrum. Among the factors to include in such a framework, in my opinion, are measures of valuation, financial conditions, and economic conditions.
Below, we have taken the liberty of combining those factors in a singular global cycle indicator (blue, rhs) that is combined with three year forward returns for the MSCI World (orange, lhs). We have used 3 years as a sufficient time frame to measure the efficacy of the approach.
Note that low readings for our cycle indicator coincide with high forward returns. You’ll see, for instance, that the genesis of the 2002-2008 bull market came from the washout that occurred by mid-2002 after the bursting of the dot.com technology bubble.
Note as well that the bull market which began in 2009 had never really seen irrationally exuberant levels in our cycle indicator (call it above 75%) and hence, forward returns have been positive since the financial crisis. This has made any form of ‘market-timing’ or tactical allocation less relevant. That is, of course, until 2017 where we hit speculative readings at some of the highest levels since the mid-2000’s. Simply put: overvalued conditions lead to low returns and undervalued conditions lead to high returns. The secret sauce is not just measuring valuation; rather, it’s combining valuation with the aforementioned factors related to economic growth and financial conditions. It amazes me that we can go cycle after cycle and these lessons are either not learned or willfully ignored by the pundits.
Overall, it is our opinion that the sharp nature of the decline seen in October is reminiscent of other “waterfall” decline moments in the past twenty years, including 2001-2002 and 2007-2008. The implication, if you haven’t figured it out already, is that October marks the beginning and not the end of the current bear market. Indeed, given where we are in the cycle, I wouldn’t be surprised if we’ll be adding 2019 to the list of historic bear markets when the post-mortem is complete.
All data for this post was sourced from Bloomberg unless otherwise stated. Content herein is neither a recommendation to buy nor sell.
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