That’s the catchy title of an article in Smart Money that details the problems facing long-term investors at the present time. It draws upon calculations of long-term expected returns made by Rob Arnott of Research Affiliates. (There’s a link to the paper in the Smart Money article.) Those expected returns, in his estimation, are low, only about 2.1% per year after inflation for a 60/40 balanced portfolio. That’s too low for most pensions and individual investors to reach their goals. Arnott and his co-author, John West, point out that returns:
can only come from four things: Dividends, earnings growth, inflation and changes in valuation.
This all sounds very bleak. You can argue with their assessment of inflation, long-term earnings growth, or valuation, but that really isn’t the point. They are mathematically correct about the sources of return. However, they have slipped in another assumption without mentioning it. It is assumed that the investor will be passive.
If low returns are all that is available to a passive investor, maybe a change in approach is in order. An individual investor has no control over inflation, so that return component will be the same for everyone. Shooting for higher earnings growth makes sense-Arnott and West suggest emerging markets-but there are also dozens of excellent growth stocks in the U.S. market. Any company that is rapidly growing revenues and earnings, either on a cyclical or a secular basis, is worth a look. High relative strength, by the way, tends to identify those companies quite effectively. Another thing that may work well is a more tactical approach that rotates across global asset classes. With a strategic asset allocation, returns are always capped at the level of the best performing asset. With a relative strength-driven tactical approach, it is quite possible to perform better than the best-performing asset over time, as the investor is holding assets only during periods of strength.
There is no good reason to passively accept low returns when other approaches may be much more effective.
Posted by Mike Moody 
