I have had a number of requests recently to update the investment return tables generated from using a credit disequilibrium approach to investing. The ex ante model which begins back in 2001 continues to outperform the market significantly by avoiding being in equities when the value of assets falls due to a contraction of credit. Since 2001 this strategy has generated 10.0% pa compared to only 3.2% in equities and 3.9% in bonds. Moreover this return has been generated with significantly lower volatility than bonds. The signal to remain in equities for 2014 at least up until now has also demonstrated that such an approach continues to perform well. Such a level of outperformance is however unrealistic in the long run, as the period since 2001 has benefited from two significant downturns.
But when looked at over the much longer term using the ex post model which has been tested back to 1986, the numbers remain compelling. Equities outperform bonds with annual returns of 7.5% versus 5.5%. However an asset allocation strategy based on movements of the ex post Wicksellian Differential generated returns of 9.4% pa with a much lower volatility than bonds.
Naturally there are differences between the ex post and ex ante returns, particularly when expectations shift during the year as happened in 2009 and 2012. The ex ante model did not signal equities until January 2010 and again in January 2013 as 2011 signaled a shift to bonds. In both instances, firms were positively surprised by the increase in profits, which in turn led to credit expansion and rising capital values. These positive surprises can also be observed in the rising earnings figures, some of which is related to firms refinancing their debt at lower costs due to loose monetary policy.
Using indications of credit expansion and contraction provide timely indicators of firms’ positive and negative surprises related to their expectations; something which neoclassical theory and its associated investment strategies mostly disregard.