Equity Valuation and Portfolio Management

ASSET CLASS PERFORMANCE VARIES ACROSS THE PHASES

The performance of other asset classes and investment styles also vary systematically with the phases. Exhibit 5.8 shows annualized real total return for U.S. equities, bonds, and the S&P GS Commodity Index for each of the phases in all of the five cycles. The general conclusions are:

• In the Despair phase a risk averse investor should own bonds, while a less risk averse investor should consider commodities. In this phase, bonds have always outperformed equities and commodities have outperformed equities in four out of five cases. The relative performance of bonds and commodities is more mixed, with commodities outperforming in three out of five cases. On a median basis, commodities have strongly outperformed bonds, but bonds are less risky with the worst annualized return being −3.7% as opposed to −20.2% for commodities. It is not surprising that equities are the poorest performer, since the Despair phase is marked by the move from the peak to the trough of the equity market, but the analysis shows how large the potential is for outperformance by diversifying into other asset classes at this point in the cycle.
• In the Hope phase, equities offer by far the best returns. In this phase there is a clear ranking of the asset classes. In all five cycles, equities outperform bonds and in four out of the five cycles, bonds in turn outperform commodities.
• In the Growth phase, commodities lead. Commodities outperformed both bonds and equities ...