QOTD: Portfolio Construction vs Trading Ideas

One of the biggest problems you encounter within financial media (and among those who consume it) is an inability to distinguish the difference between what is relevant over longer time frames versus what is relevant right now. It’s really hard both from the standpoint of the producers of content and the receivers of the information.

Chris Brightman at Research Affiliates does a nice job of explaining this in his new piece on the implications of negative interest rates. Brightman looks at the earnings yield of equity markets and the interest rate yield of bond markets in making the point that both of these yields have been highly predictive of subsequent returns ten years out.

But what you do with this information would be highly different depending on what time frame you’re focused on…

Ten-year real return forecasts are a valuable input to long-term investment planning! For investors who establish and stick to long-term plans and are able to persist with those plans over multi-year periods—for those with the conviction to increase positions that have disappointed over recent years—read on. Traders beware. Long-term return forecasts can be worse than useless for those looking for a trade. Over periods of months (and even a year or two), such forecasts are not much better than random noise. Frequent trading on such signals will enrich your broker, not you.

Josh here – in my commentary on markets here and elsewhere, I often struggle with this and it’s not entirely my own ineptitude as a communicator that is at fault. A speaker almost never knows the time frames and objectives of all members of his or her audience when making a comment. Short of wearing a hat that says “I’m saying this for traders” or “Investors Only”, it’s very hard to try to speak to both and have everyone understand the nuance of the statement you’re making.

A ten-year return forecast can end up being right but look spectacularly wrong several times on the way toward getting there. Despite the extraordinary longer term explanatory power of real earnings yields or real interest rates, the instruments they’re attached to will never behave in such a way as to make you feel comfortable along the journey.


Negative Rates Are Dangerous to Your Wealth (Research Affiliates)

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