Below is a round-up of Longview related views/research & trade ideas – the intention is to publish this most Fridays, updating key themes and highlighting key pieces of (often contrarian) research. Feedback, as always, is appreciated. Equally just ‘unsubscribe’ at the bottom if you don’t want to receive the email.
Asset Allocation: The Theory of (almost) Everything
“Whatever is has already been, and what will be has been before”
Ecclesiastes 3:15
Whilst timing investment cycles using solely the rhythm of history is challenging, the analysis of the short, long and super long cycles provides considerable context and signposts for making long term asset allocation decisions (as well as context for analysing current economic times).
In this week’s Longview Letter (HERE), we have revisited and re-examined those long secular cycles: That is, the 15 - 30 year cycles in equities, commodities and bonds. The US long cycles in equity markets are shown below - see FIG 1. The chart illustrates the breakout to a new secular bull market in US equities since post the Euro crisis (or arguably since the 2009 lows). It also shows the strong long term gains in US equities (NB FIG 1 is in real terms with a log scale) over the past 100+ years.
FIG 1: S&P500 & DJIA equity indices (deflated by CPI, rebased to 100 in 1900, log)
If we then take the same chart and remove the logarithmic Y axis scale and rebase it to 100 at the turn of the 20th century (i.e. 1900), then the extent of the (real, inflation adjusted) price gains in US equities* becomes self-evident. Since 1900, US equities have increased by 14.2x.
FIG 2: S&P500 & DJIA equity indices (deflated by CPI, rebased to 100 in 1900)
*Naturally here, and in all the charts shown, dividends are also a significant part of the total return. Due to lack of long data histories, though, the total return indices we have exclude dividends.
If our long cycle analysis is correct, then one key conclusion is as follows:
“the US equity market is (and remains) in a structural bull market. Usually secular bear markets in commodities last between 12 to 21 years. This commodity bear market is 7 years old. Simplistically, therefore, the secular bull market in US equities should persist for another 5 – 14 years”
Source: Longview Letter no 118, 15th November 2018
Looking beyond US shores, though, it’s interesting to examine the evidence for the long cycle pattern in European equity markets. In the UK, for example, the FTSE All share index behaves in a similar manner to the US equity market in relation to commodity super cycles (using data back to 1880, FIG 3). That is, during commodity secular BULL cycles the UK equity market underperforms markedly, whilst during commodity secular BEAR cycles the index generates sharp, strong real returns.
FIG 3: UK FTSE equity index** (real terms, log scale) – shown with commodity super cycles
** NB this index doesn’t include dividends which are a meaningful part of the total return.
Equally in Germany, whilst the data is more limited, in the past 60 years, the relationship holds***, i.e. secular equity cycles in Germany are negatively correlated with commodity super cycles. This chart also concurs with the long cycle conclusion for the US equity market above, i.e. that a new secular bull cycle is underway.
FIG 4: German DAX TR index (real terms, log) shown with commodity super cycles
***although arguably some question marks exist in relation to the 1960s price action. Limited historical data, though, doesn’t allow us to conclude on that point.
For other parts of Europe, though, where specific local economic issues are more important drivers of the domestic economy, stock markets remain anchored near multi decade lows. The Greek stock market is an obvious example – see FIG 5…
FIG 5: Greek equity market (deflated by Greek CPI, rebased to 100 at start of data)
Equally, the Italian stock market is similar to the Greek example (remaining mired near 30 year lows) ….
FIG 6: Italian equity index (deflated by Italian CPI, rebased)
…while Europe, as a whole, remains rangebound reflecting that mix highlighted above, i.e. some better performing markets (like Germany) and other poorly performing countries (like Greece and Italy). From a (real terms) price perspective, therefore, Europe hasn’t broken out into a new secular bull market (FIG 7).
FIG 7: European equity index (deflated by CPI, rebased)
That continued poor performance, in contrast to the US & UK equity markets, reflects the political and economic challenges in the Euro zone brought about by the Euro project. These challenges manifested themselves most notably during the Euro crisis, but still continue to simmer in the background (or in the case of Italy, simmer in the foreground).
Overall, though, these charts illustrate the powerful signalling mechanism of local stock markets and the importance of understanding country specific risk, as well as the long-term global cycles, when engaging in long term asset allocation decisions.
One other observation, the super long cycles and BREXIT
Looking again at the UK (FIG 8), it’s also important to highlight that the chart hides the remarkably poor price returns in the FTSE index over the past 140 years (i.e. because it’s scaled logarithmically). Without the logarithmic scale, it’s easier to grasp the real price returns: In particular, on the latest data (i.e. at end of 2017), the real price level of the FTSE index is unchanged versus the late 1800s. That is, since the time of the height of British Empire, until today, the real price return of the FTSE index has been cumulatively zero (FIG 8). That total 120 year period, though, can be split into two super long cycles: 1900 – mid 1970s (a period of marked decline in the stock market); & mid 1970s until today (a period of overall strong gains).
FIG 8: UK FTSE equity index (real terms) – shown with commodity super cycles
Of further note, translated into an overseas currency, that price performance (especially up until the 1970s) deteriorates further. As the UK’s global reach/power has declined over the past 100 years, its currency has followed, devaluing significantly up until the early 1980s.
FIG 9: GB£ vs US$ spot exchange rate (since 1880)
The contrast, therefore, between the US and the UK equity market, from late 1880s up until the mid-1970s, is striking. During that phase, the US’s stock market performance reflected the US’s ‘ascent to (global) empire’ status, and the structurally strong economy and strong growth, that is always associated with that phase (to paraphrase David Murrin, a historian of the ‘Cycle of Empires’ – see “Breaking the Code of History”, published 2010). In contrast, the UK market’s poor performance reflected the country’s ‘post empire’ decline (i.e. from around 1900 through to the mid 1970s/1980).
Of encouragement to investors in UK assets, though, the performance of both the currency and stock market have improved in recent decades. Indeed, from the time of the start of the Thatcher reforms in the 1980s, the currency has stabilised (i.e. the prior steady devaluation of the GB£ has stopped) and the stock market has performed well.
In that respect, if BREXIT is part of the continued regeneration of the UK system**** (i.e. in the long term historical sense as articulated by David Murrin in his book), then it may also mark another further key turning point in the super long cycle of history (i.e. with Margaret Thatcher’s reforms marking the first key turning point). Much will, no doubt, depend on the outcome of the ‘dark art’ of Westminster politics over coming weeks (i.e. whether a deal passes or is reformed, whether May stays in power or there’s a new Tory leader, and so on). If, however, a deal is achieved that ultimately enables the UK to reclaim full sovereignty, then a further step in that regeneration will probably have been taken as the UK begins to develop new systems of governance, a core part of the reinvigoration puzzle (i.e. which occurs post the decline phase).
****and that is a big ‘if’.
Have a great weekend.
Kind regards,
Longview
Research published this week
This week:
Longview Letter No. 118, 15th November 2018
“Asset Allocation: The Theory of (almost) Everything” – available HERE
Commodity Fundamentals Report No. 87, 14th November 2018:
"Uranium - The Ultimate (geopolitical) Hedge" – available HERE
Weekly Market Positioning Update, 12th Nov 2018:
"Oil positioning - shifting sharply"
Last week:
LV on Friday, 9th November 2018:
"Beware the ‘palpable’ relief… plus rotation into defensives – half way done" – available HERE
Macro Trade Recommendation No. 94 , 6th November 2018:
“Start BUILDing LONG OIL Futures Positions” – available HERE
Tactical Equity Asset Allocation No. 178, 6th November 2018:
“Relief Rally to Continue” – available HERE
Weekly Market Positioning Update, 5th Nov 2018:
"(Positioning) Unwind Continues"
