What works in a sideways world?


I’m not the only investment manager who thinks we are in for a drawn-out number of years in which plain vanilla balanced portfolios earn low- to mid-single-digit returns. Bonds are obviously priced to yield low returns, and it’s hard to make a rational argument that stocks are priced any better.

The only people I hear touting stocks these days are people who sell stocks or stock mutual funds or who are on television and don’t manage money for real people for a living.

These periods of long sideways returns happen regularly. They usually last for a dozen or more years. The last one carried on from about 1968 to 1982. If we adjust the returns for inflation - which we must - that last sideways period lasted for 25 years. Think about that for a moment: 25 years with zero return.

It is my decided view that we are in the midst of such a sideways cycle right now. We had the market drop in 2000-2002, and we’ve had a rally in 2003-2005, but we’re really just going nowhere. That will continue until the price-earnings ratio bottoms out at about half its current level, and then it is possible to once again have a long bull market. Your children will enjoy that market, but you should make plans for something more mundane.

Naturally, investors will wonder what is to be done in such a market. Should they be satisfied with buying certificates of deposit or inflation-adjusted treasury notes? While these investments are safe and will likely keep inflation at bay, they are hardly scintillating.

Financial planners will pull out charts and diagrams based on a thing called Modern Portfolio Theory and project a far rosier outlook than the one you see in the real world. The only problem with Modern Portfolio Theory is that it is anything but modern and it has long since been shown to be all but worthless in managing actual portfolios.

Is there anything in our lives that was invented in the early 1950s that we still call modern?

The entire industry of personal financial planning and advice was created in the last 25 years. By a happy coincidence, this industry grew up in a bull market period. As the decades wore on, our business became ossified in the notion of buy and hold. Now that the long bull market is gone, buy and hold has become buy and hope. The buy and hope adviser will find himself in a new career 10 years from now.

An investment era like the present one requires that advisors and investors get up off their duffs and work hard. It is not enough to sit back and let the rising tide of the S&P 500 continually bail us out of our complacency and lazy decision-making.

Value-based decision-making becomes paramount. We can no longer blindly buy a stock index fund and hope for the best. We have to first decide whether the stocks in that index are cheap. If they are not, we move on down the proverbial aisle and find something that is.

Our financial resources need to be husbanded and doled out only to those investments whose market price and earnings potential combine to produce a high expected return. It is not enough to merely buy a so-called value-stock fund.

Most such funds own fiendishly expensive stocks, by my reckoning. They are merely less fiendishly expensive than their growth-stock cousins. Hardly a value, if you ask me.

Investors and advisers who are not equipped to perform this analysis on their own will need to allocate their investment dollars to managers who are. Without making any promises they will succeed at the task, I suggest mutual funds such as the PIMCO All-Asset Fund, available through most discount brokers.

Other candidates include some funds managed by the Leuthold group. What these funds, and others, have in common is a manager who has a stated objective of varying the mix of assets in the fund according to the manager’s own judgment of changing valuation conditions.

You should look for such funds or instruct your adviser to do so.

The objective is to make modest shifts among stocks and bonds and other assets in response to changing economic and valuation conditions. This sort of investment discipline has historically performed far better than ordinary balanced portfolios in sideways markets.