Cliff Asness on Future Equity Returns Using CAPEVW Staff
Barron’s interview with Cliff Asness of AQR on a 60/40 stock/bond portfolio, future returns, alpha and more.
Barron’s: What kind of a return can investors expect using a traditional portfolio of 60% stocks and 40% bonds?
Asness: This is U.S. stocks and bonds, but it’s not that different if you do it globally. Historically, we think about real returns, and that 60-40 portfolio has delivered about 5% per annum over inflation over the long term. However, passive investors now would be better off to assume about a 2.5% real return, which is still positive and still going to beat inflation. But using valuation metrics alone can make for a lonely, long, and sometimes sad ride if one is trying to beat the market. The market can stay overvalued or undervalued for long periods, and valuation isn’t the only factor in the shorter term. But these metrics can help set long-term expectations, such as calculating how much to save.
“A 60-40 blend of stocks and bonds has been cheaper than it is now 98% of the time.” — Cliff Asness
What’s the reason for your estimated 2.5% annual real return, which is low by historical standards?
We don’t look at much else besides price. Business cycles, short-term earnings growth, who’s beating their number, what the Fed does next week—that all does matter a lot over the short term. But over the long term, while there is no perfect predictor, the only factor that has decent predictive power is, “What price am I paying against fundamentals?” There are a lot of ways to measure it, and we have our favorites for stocks. We are fans of things like the famous Shiller P/E [a price-earnings ratio calculated on average inflation-adjusted earnings over the preceding 10 years]. But most of the ways we look at it come out with fairly similar measures, notably that stocks have been cheaper than they are now more than 80% of the time. Bonds have been cheaper about 90% of the time.
Which is intuitive, considering how low interest rates are, even with the recent rise in yields.
It’s absolutely intuitive. But it’s actually worse for that 60-40 combination of stocks and bonds, and that’s where a lot of people’s intuition might fail them. The 60-40 portfolio has been cheaper than it is now 98% of the time. Now, we’ve seen more-expensive bond markets, and we’ve seen more-expensive equity markets. For instance, right now it’s not close to the peak of the tech bubble in 1999-2000. However, the stock and bond markets are usually not expensive, with a low expected return, at the same time. Take the peak of the tech bubble as an example, when stocks were ridiculously expensive, offering a very low prospective return. But unlike now, bonds were offering a real return of 4% and change, just for showing up. So very often when one asset class is very expensive, the other one isn’t. Right now, they are different degrees of very expensive, and the combination is even more extreme than either one. So that really is sad news for passive investors. Actually, it’s sad news for all investors. It means there is no place to hide, even if you are a believer in long-term tactical asset allocation. I don’t mean timing the market. You can make a move from one asset class to the other, but you don’t’ pick up that much, and you take on a lot of lack of diversification. And there is a lot of concentration risk.
Full article LAWRENCE C. STRAUSS of Barron’s