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When evaluating a money manager, some investors neglect to explore the rationale behind a manager’s investing process and/or retirement planning process. You can’t buy a manager’s past returns and forecasts, but you can determine if the firm has a demonstrated research process that differentiates it from competitors.
Without proof of a demonstrable process, you can’t know whether a money manager’s forecasting and investing decisions are well-researched, or based on questionable or faulty theses.
If you are working with an advisor or broker boasting high returns on their past recommendations or forecasts, it may help to request a proof of process. How did they choose previous recommendations and what were they based on? Do they recommend products based on sound research and a forward looking analysis or are they recommending higher-commission products, such as annuities, for most of their clients?
In our view, a rigorous and detailed approach can be a powerful asset to your portfolio.
This mindset applies to any financial or retirement planning decision you make, including the following:
Doing in-depth market research and following a time-tested process to identify investment opportunities is a crucial part of an investment strategy. Fisher Investments has done this for decades. Analyzing market phenomena regularly and testing the probabilities of outcomes allows us to think independently from the herd.
Rigorously analyzing market opportunities could enhance the overall investing and retirement process. This can apply to any investor (retiree or still employed) who anticipates relying on portfolio-generated cash flow in the future.
But most important, our process isn’t a “black box.” We make it transparent for all investors and institutions through our regular publications. It is an important way to show the substance behind our solutions, particularly when such solutions go against conventional wisdom.
Doing rigorous historical research can have a sobering effect on traditional assumptions. Sometimes, a popular or long-held belief crumbles under historical scrutiny. Here are a few myths we have debunked along the way:
Myth #1: Rate hikes are bad for stocks. Many investors fear rising interest rates might spell doom for the stock market—especially following the first rate hike of a tightening cycle. However, since 1971, US stock market returns were up an average of 4%, 5% and 11% in the 6, 12 and 18 months (respectively) following an initial Fed Funds rate hike.[i] Empirical evidence simply doesn’t support the view that an initial rate hike spells market doom.
Exhibit 1: S&P 500 Returns After Fed Funds Rate Hikes
Source: FactSet, as of 11/17/2017. S&P 500 Index daily total return from 7/15/1971 to 9/30/2017.
Myth #2: High P/E ratios mean stocks are overvalued and subpar returns will follow. How might you evaluate whether stock prices are soaring too high? Some investors look to the price-to-earnings (P/E) ratio, which compares a stock’s or index’s price to its earnings per share over a given period. Investors often assume current equity valuations predict future returns—but they don’t. P/E ratios can be useful as an indirect (albeit imperfect) gauge of investor sentiment, but misconceptions about their predictive power don’t stand up to scrutiny.
For example, in October 2002, the MSCI World Index 12-month forward P/E ratio was around the 25-year average of 16.[ii] What followed? A five-year bull market. Conversely, the P/E ratio in August 2007 was below average, and stocks subsequently entered a bear market.[iii] P/Es simply aren’t predictive, despite the common belief that they are.
P/E ratios can be an imperfect gauge of investor sentiment, an element that can drive the market in the short term. Fundamental factors ultimately drive markets over the long haul.
Myth #3: Budget deficits are bad for stocks. People tend to worry that a period of poor stock market performance may follow a period of higher federal budget deficits. But as counterintuitive as it may seem, high stock market returns tend to follow deficit extremes rather than surplus peaks or deficit decreases. If you think of the government as a corporation, using leverage to spur growth doesn’t seem like such a strange dynamic. Exhibits 2 and 3 illustrate S&P 500 Index price returns are actually lower on average following US budget surplus peaks than they are following extreme US budget deficits.
Exhibit 2: Budget Surplus/Decreasing Deficits
Source: Federal Reserve Economic Data, as of 4/2/2019; Qtrly Net Federal Govt Saving, SAAR, 1/1/1947–12/31/2018; Qtrly Gross; Domestic Product, SAAR, 1/1/194 –10/1/2018. FactSet, as of 4/2/2019; S&P 500 Price Return Index Level, 1/1/47–12/31/2018.
Exhibit 3: Budget Deficits
Source: Federal Reserve Economic Data, as of 4/2/2019; Qtrly Net Federal Govt Saving, SAAR, 1/1/1947–12/31/2018; Qtrly Gross; Domestic Product, SAAR, 1/1/194 –10/1/2018. FactSet, as of 4/2/2019; S&P 500 Price Return Index Level, 1/1/47–12/31/2018.
Any form of financial planning or investing should be a detailed and disciplined process backed by history and research. This includes decisions concerning your retirement planning, retirement savings, Social Security and any other retirement income benefits for which you may be eligible.
The quality of your retirement planning and investment decisions hinges on the quality of your thinking. This applies to young investors as well as those soon-to-be retired and looking to boost retirement savings to enjoy higher retirement income and cash flow.
Fisher Investments may be able to help you identify your goals and alleviate some of the stress associated with managing your portfolio. We take an active approach to money management and have a disciplined process to researching and navigating markets. Our tried-and-true processes may be able to help you on your way to achieving your long-term investing goals.
[i] Source: FactSet, as of 11/17/2017. S&P 500 Index daily total return from 7/15/1971 to 9/30/2017.
[ii] Source: Thomson Quantitative Analytics, as of 1/9/2018. Weekly MSCI World 12-Month Forward P/E Ratio from 1/31/1988 to 11/30/2017. 25-year average 12-month Forward P/E Ratio of 16.3 as of 11/30/2017 and MSCI World 12-month Forward P/E Ratio of 15.9 on 10/31/2002.
[iii] Source: Thomson Quantitative Analytics, as of 1/9/2018. Weekly MSCI World 12-Month Forward P/E Ratio from 1/31/1988 to 11/30/2017. 25-year average 12-month Forward P/E Ratio of 16.3 as of 11/30/2017 and MSCI World 12-month Forward P/E Ratio of 13.7 on 8/30/2007.
