Investors tend to put past performance in the driver’s seat

By Dan Suzuki, CFA, Deputy Chief Investment Officer, Richard Bernstein Advisors

With corporate profit fundamentals continuing to deteriorate, it seems premature to position for the next bull market. But assuming the recent spike in volatility is signaling a change in market leadership is underway (as it historically has), then how should we start to think about strategic allocations for the next 5-10 years? Before answering that question, it is important to recognize the tendency of investors to invest in the rearview mirror. Regardless of the ubiquitous compliance warning that “past performance is not indicative of future returns,” investors tend to look at upward-sloping price charts and decide, “I’m missing out; I need some of that in my portfolio.”

King for a day

Empirically, it is the antithesis of this strategy that has historically worked. Tables 1 and 2 show the historical performance over five-year periods for (1) ten different equity categories and (2) US sectors. The best-performing segment of the equity markets during one five-year period was rarely the best-performing segment during any subsequent period. Even the top three market leaders rarely repeat among the top three in any subsequent period, and most often the top three for one period actually underperform in the subsequent period. There were exceptions, all of which turned into the most notable bubbles in recent history: Tech/Growth in the 1990s, Financials in the late-1990s and early-2000s and Energy/Emerging Markets in the 2000s.

What that means for the next bull market

At RBA, we will let the fundamentals be our ultimate guide, but as we think about what segments could lead the next bull market, it seems very unlikely that the dominant strategies of the prior bull market will maintain their leadership. That bodes poorly for US large cap growth stocks, especially given their leadership over the most recent back-to-back five-year periods. It is no coincidence that this conclusion is the complete opposite of what is currently considered “obvious,” particularly after the resilience that high growth Tech has experienced this year. But that is the point. Whether it was selling tech in 2000-2001 or selling emerging markets in 2009, the prudent strategy is often counter to what seems “obvious” at the time.

Dan Suzuki, CFA, Deputy Chief Investment Officer

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