Posted by Barry Gilbert, PhD, CFA, Asset Allocation Strategist
Wednesday, July 27, 2022
Investors love to chase returns. In the near term it can potentially be a successful strategy that has some strong academic and industry research behind it. But nothing lasts forever and markets move in cycles. One reason is the more a segment of the equity market outperforms, the greater the potential for it to become mispriced as sentiment runs ahead of fundamentals. Sentiment can run hot for a long time, and there’s no rules for how long these cycles may last, but at some point there’s typically a comeuppance. Historically a decade has often been long enough to see some meaningful reversals. Our basic conclusion: based on history, outperformers over the last 10 years tend to be underperformers over the next 10 and vice versa.
“Once a segment of the market has underperformed for a decade, it is often so hated many investors actively avoid it,” said LPL Asset Allocation Strategist Barry Gilbert. “As a result, that’s often when that segment becomes statistically favored to outperform.”
As shown in the LPL Chart of the Day, looking at 22 major segments of the equity market, outperformers in one decade became underperformers over the next decade over every rolling period, starting with the comparison of 1990-1999 and 2000-2020. In fact, an average of 6.0% of outperformance from the winners in the starting decade became an average of 2.8% of outperformance from the prior losers in the next.
The study suggests that the right thing to do when positioning tactically may not be the same as the right thing to do when positioning strategically, but taking advantage of that difference takes patience. So what were the underperformers from 2012-2021 that may be potential outperformers over the next decade? The Russell 1000 Value, Russell Mid-Cap Value, Russell 2000, Russell 2000 Value, MSCI EAFE, MSCI Emerging Markets, and the S&P Dow Jones Select Sector indexes for energy, materials, consumer staples, communication services, and utilities. It looks like an awful list judging from the last decade—but that’s the point. For long-term investors, these areas may be worth considering for mean reversion opportunities.
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