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28 of 29 people found the following review helpful:
5.0 out of 5 stars
Reversion to the Mean, March 20, 2007
In Predicting the Markets of Tomorrow author James O'Shaughnessy offers his ideas on the investment environment we are likely to encounter over the 20 years from 2006 through 2026. He selected twenty years as this time horizon based on extensive analysis of market behavior over approximately the last 200 years. His logic goes something like this:
1. When calculating returns from any investment strategy, it is essential to focus on the real return, after accounting for inflation.
2. Approximately two hundred years of stock market data (1809-2004) show that real returns have been highly erratic, especially when analyzed over periods of a few years or less.
3. However, when one calculates returns using overlapping periods of 20 years, they become much smoother. Stocks have rarely lost value over a 20 year period.
4. There are probably some underlying factors that cause returns to be smoother over 20 years. O'Shaughnessy suggests two. First, many investors don't really get started saving and investing until their mid 40s, giving than about 20 years to accumulate assets before retiring. Second, retirement at 65 together with a life expectancy of 85 suggests retirements (and asset depletion cycles) that last about 20 years.
5. If one decomposes the 20 year average returns of the S&P into the returns of the growth and the value stocks that comprise the S&P, these two groups have tended to move out of cycle with each other. Growth stocks occasionally have produced the higher return, as they did in the 1980s and 1990s. More often, value stocks have outperformed value stocks.
6. The returns of these three groups (S&P, Growth, and Value) all seem to revert to their mean rates of return. Any group that has outperformed in a 20 year interval is likely to underperform in the next 20 year period.
7. Since growth stocks outperformed in the 1980s and 90s, it's now their turn to underperform while value stocks outperform.
8. One can also segment the market by the capitalization (the total value of all the shares of a company). This analysis suggests that small cap stocks are likely to outperform large cap stocks over the next 20 years.
9. The average 20 year real returns /standard deviations of the key market groups between 1947 and 2004 have been:
Large Cap Growth: 6.26% / 3.83%
S&P 500: 7.30% / 3.76%
Large Cap Value: 10.32% / 3.42%
Small Cap: 10.42% / 2.94%
10. As seen in the figures above, Large Cap Value and Small Cap stocks have higher returns with lower standard deviations. When you add on the fact that these two groups have underperformed over the last 20 years, O'Shaughnessy appears to have a compelling argument for focusing on these two groups. To hedge his bets slightly, he recommends a preferred portfolio allocation of 50% large cap value, 35% small cap growth, and 15% large cap growth.
11. Fixed income securities, even inflation protected treasuries (TIPS) are currently producing returns that, at best, break even. They are "Return-free risks, not risk-free returns". Avoid them except as a place to park cash they you will need in the next few years.
Reviewer's Comments: I agree with O'Shaughnessy's approach and conclusions but would have liked a better justification for using 20 year average returns. One could argue that generations are separated by about 25 years which might make that figure the logical interval for averaging. Perhaps someone has (or should) compare the results of averaging over different periods such as 10, 15, 20, 25 and 30 years. Or, even better, use a Fast Fourier Transform to determine the power spectral density of each time series.
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38 of 48 people found the following review helpful:
2.0 out of 5 stars
Not recommended, September 3, 2006
This review is from: Predicting the Markets of Tomorrow: A Contrarian Investment Strategy for the Next Twenty Years (Hardcover)
Not recommended. This allegedly "contrarian" book argues that the hot trends of the last 6 years (outperformance by small and value stocks) will continue for the next 20. I find any argument for the continuation of well-established trends inherently suspicious, but purchased this anyway to challenge my notion (based on other sources, mostly Morningstar) that large growth is attractively valued right now (even if French & Fama are right about small & value being best in the long run).
I didn't find much to challenge my view. The author's argument seems to be based entirely on reversion to mean, without any consideration of current valuations (P/E, Price/Book, Price/Sales) of the different market segments.
Two aspects raise the specter of data mining. First, the reversion analysis is based entirely on 20-year rolling data, but the grounds for picking 20 are thin. He says it's a typical holding period, but so are 10 and 25; I see no curiosity displayed whether the results would hold if different periods were used. Second, the stock picking rules laid out in Chapter 8, singled out for praise by another reviewer, give the appearance of having been selected from thousands of possible rules. I can't tell if these were previously published and have worked since then, but the backtesting is ALWAYS spectacular, and if enough rules were tried then the success of these was just random chance.
The author's portfolio recommendations are all domestic equity, and compared to a strawman historically bad allocation. Bonds are ultimately dismissed, although the chapter devoted to them contains some good information. REIT's, international investing, and commodities are skipped over in favor of advice to hire an advisor (which the author happens to be). The chapter on asset allocation should thus be called "My domestic stock picks," and contains no analysis of the benefits of rebalancing volatile asset classes. It's almost surely a mistake to own more than ~80% stocks, but you'd never know that from reading this book.
Another problem is the author's simultaneous praise at pp. 181 and 183-84 for the respective selection criteria of the Vanguard Value and Growth ETF's. The MSCI indexes (on which these funds are based) are just the flip sides of a coin. Of the 750 largest U.S. stocks, each index (and fund) contains only and exactly what the other does not. Thus if one is good, the other is bad. Ownership in both makes a simple cap-weighted index of the top 750 stocks (similar to S&P 500 funds, which the author elsewhere condemns).
In fairness, there is some good information on the tech boom and bust, demographics, and 401(k)'s. My bottom line, though, is that I got more out of both Richard Ferri's book on Asset Allocation, and William Bernstein's Four Pillars of Investing, even though it's out of date.
One final nit: IBM did not create the first laptop computer, in 1986, as stated on p. 242. That was Data General, in 1984.
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25 of 32 people found the following review helpful:
5.0 out of 5 stars
Excellent and clear research, March 29, 2006
This review is from: Predicting the Markets of Tomorrow: A Contrarian Investment Strategy for the Next Twenty Years (Hardcover)
I have read many investment books -- this is one of the best. It offers clear guidance and solid research to back up the predictions and claims. The claim that small-cap value stocks will outperform all the rest is backed by careful historical analysis and testing. I especially like the fact that the research done is for an appropriate time frame for those of us worried about retirement -- 20 years, and that "real returns" -- inflation-adjusted returns -- are used, instead of nominal returns that are most often cited by books and websites. The only hesitation I have in following the advice in this book is to invest in 10 large cap value stocks -- one of them, like GM, can easily go bankrupt and wipe out 10% of the portfolio value. I personally would stick to ETF, unless I have enough capital to hold at least 25 stocks in my portfolio. All in all, good, clear, and simple investment advice with serious research.
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