On Buying Unloved Assets; How Much Sleep do we Need?

From: aditya rana
Date: Sat, Oct 24, 2015 at 1:11 PM
Subject: On Buying Unloved Assets; How Much Sleep do we Need?


Global markets posted a long awaited rebound in October, led by Russia (up 17% in dollars – all returns below are in dollars), the Shanghai composite index (up 12%), followed by various emerging markets and rounded up by the developed markets (US up 6%). It is interesting to observe that one of the best performing asset class this year have been 10-year Greek government bonds – up 8% – which might seem surprising given the widespread expectations of an imminent Greek default and Grexit earlier in the year. Within the equity space, Italian equities (another unloved country!) takes the premier spot returning 11% , followed by Russia (up 9% – and even more unloved!). Even China has put in a decent performance with the Shanghai index being up 4% (versus -1% for the US), but the real outliers have been the more speculative Shenzen and Chi-next indices which have posted +41% and + 70% returns for the year. The point to note here is that it is usually the most unloved assets which subsequently provide superior returns to the disciplined and patient investor. So what has been the worst performing asset this year? 10-year Brazilian real government bonds by far, having returned -49% in dollars (out of which -32% is due to the FX impact) making it very likely that they will provide superior returns over the coming years. Expanding further on this theme of buying unloved assets, Chris Brightman, CIO of the reputed research advisory firm Research Affiliates, wrote a note recently on this subject. To summarise:

-There exists today a wide valuation differential between US and EM equity markets, with the US market being priced at a Shiller P/E of 25 versus a historical median of 16 implying expected 10-year real returns of a measly 1.1%. By contrast, EM equities are priced at a Shiller P/E of 11 (a historical low since 1990) versus a historical median of 19 implying an expected 10-year real return of 8% (see table below).

-Investors with the objective of building long-term wealth, should ignore short-term fluctuations in markets and actually welcome price declines as an opportunity to add exposure to markets with cheap valuations. High priced markets like the US are risky while cheap markets like EMs are relatively safer.

-EM equities are widely unloved today, like in the late 1990s, but the environment then was much worse. In 1997 the Thai baht collapsed triggering a collapse in the currencies and stock markets of South-East Asia along with the relatively more developed markets of Hong Kong, Singapore, South Korea and Taiwan. Russia was waging a war in Chechnya and the rouble crisis followed a year later with Russia defaulting on its internal debt. Oil prices collapsed to $10 per barrel and EM equities were widely unloved, while US tech stocks were booming.

-The political, economic environment and relative valuations between the US and EM from the period 2008 until 2015 rhymes with the period 1994 (when EMs peaked) until 2002. From 1990 until 1992, and from late 2006 until early 2007, both the US and EMs were valued at roughly the same Shiller P/E (“CAPE”) ratios (see graph below)

-However, by early 1994, enthusiasm for Asia-driven growth of EMs boosted their CAPE levels to 30, a 30% premium to the US market. Similarly, in early 2008, enthusiasm for China-driven growth of EMs propelled their CAPE levels to 35, a 25% premium to US CAPE.

-But later in 1994 problems in EMs from Fed tightening (the Tequila crisis) caused EM equities to decline back to a CAPE of 20 over the following year. Similarly, in 2013 fear of Fed tightening (the Taper Tantrum) caused EM equities to decline to a CAPE of 15.

-By contrast, from 1995 until 1999, US markets led by tech stocks soared, while EM equities tanked and the US CAPE was finally priced more than double than that of EM during the period 1997 until early 2003. Today, the US market CAPE is again priced at more than double that of EM. This movie is likely to have a familiar ending.

-Looking at 10-year real returns (see graph below) , the real returns from investing in the US market at peak prices from October 1997 until April 2003 ranged from 5% to -5% with an average of 0%. While the 10-year real returns from investing in EM equities over this period (priced at less than half of US CAPE) ranged from 5% to 15% and averaged 11% (see second graph below).

-The future 10-year lines in the above graph end in 2005 as the returns from 2006 will only be known in 2016. It is clear from the graphs that CAPE provides good guidance for 10-year expected returns, and the current expected 10-year returns for the US of 1.1% versus 8% for EM illustrate the stark divergence in opportunities.

-For long-term investors, short-term price volatility is an opportunity while high prices are a risk. Buying cheap EM assets and reducing exposure to expensive US assets is a prudent risk lowering/return enhancing strategy for patient investors.

-A powerful case for investing in cheaply valued EM equities and reducing exposure to expensive US equities – while this may not work for the next year or so, the outlook over the longer-term (5 years plus) is compelling. Having a core portfolio in EM, and adding to that exposure if EM equities fall further, would be a reasonable strategy. In light of the likelihood of increased market volatility with uncertainty regarding a Fed rate hike, and as noted in my recent newsletters, it might make sense to raise some cash (while maintaining a core holding) if the rally continues into year-end. This would allow one to redeploy the cash if markets suffer a sharp downturn in the coming months (see graph below for a useful signal to monitor). However, staying the course with EM assets and ignoring the short-term market volatility would also make sense for patient investors.

-To hedge equity portfolios against short-term market volatility, investors may also consider 10-year US Treasury bonds, which have shown a strongly negative correlation to the S&P in recent months.

-To the extent that the market volatility during the months of August and September might have unnerved you, please see the following observation made (by Gary Scott) on Warren Buffet’s resilience:

“For example, from June 30, 1998 to February 29, 2000, Berkshire lost 44% of its market value while the overall stock market gained 32%. Most fund managers would have trouble surviving a shortfall of 76%. Buffett’s reputation and structure as a corporation helped him stay the course and rebound when the internet bubble burst. Having not leveraged too much was a crucial part of his tenacity.”

How much sleep do we need?

The ancient Indian medical system, Ayurveda, recommends that an average healthy human needs 6 hours of sleep, with minor variations around this mean based on age, seasons and physiology. So it interesting to note a recent study by UCLA which corroborates this concept:

http://newsroom.ucla.edu/releases/our-ancestors-probably-didnt-get-8-hours-a-night-either . October 15, 2015.

-A UCLA-led team of researchers found among the Hadza of Tanzania, the San of Namibia ( both hunter-gatherers) and the Tsimane of Bolivia (hunter-horticulturalists ) challenges conventional wisdom about the sleeping habits of pre-industrial humans. The study suggests that the industrialized world’s sleep habits do not differ much from those that humans evolved to have.

-“The argument has always been that modern life has reduced our sleep time below the amount our ancestors got, but our data indicates that this is a myth,” said Jerome Siegel, leader of the research team, and an international authority on sleep, Siegel is a past president of the Sleep Research Society. For 40 years, he has run a basic sleep research lab in Los Angeles.

-Using special watch-sized devices that measure sleeping and waking times as well as light exposure during the summer and winter, they measured their body temperatures, the temperature in their environment and the amount of light to which they were exposed. The study is the first on the sleep habits of people who maintain foraging and traditional hunting lifestyles in the present day.

-Most of the people studied by the team slept less than seven hours each night, clocking an average of six hours and 25 minutes. The amount is at the low end of sleep averages documented among adults in industrialized societies in Europe and America.

-One myth dispelled by the results is that in earlier eras people went to bed at sundown. The subjects of the study stayed awake an average of 3 hours and 20 minutes after sunset. “The fact that we all stay up hours after sunset is absolutely normal and does not appear to be a new development, although electric lights may have further extended this natural waking period,” said Siegel.

-“There’s this expectation that we should all be sleeping eight or nine hours a night and that if you took away modern technology people would be sleeping more, But now for the first time we’re showing that’s not true” said one of the researchers.

-There is no evidence that these sleep patterns took a toll on people’s health. In fact, extensive studies have found that these groups have lower levels of obesity, blood pressure and atherosclerosis than people in industrialized societies, and higher levels of physical fitness.

-The amount they slept varied with the seasons, with the study’s subjects averaging six hours in the summer and just under seven hours in the winter. Still, they rarely took naps.“There’s this myth that humans used to take daily naps, but that now — because we’re so busy and we can’t get back to our homes — we suppress the naps,” Siegel said. “In fact, napping, is relatively rare in these groups.”

-Insomnia was so rare among those studied that the San and the Tsimane do not have a word for the disorder, which affects more than 20 percent of Americans. The reason may have to do with sleep temperature. The people studied consistently slept during the nightly period of declining ambient temperature. Invariably, they woke up when temperatures, having fallen all night, hit the lowest point in the 24-hour period. This was the case even when the lowest temperature occurred after daybreak. The pattern resulted in roughly the same wake-up time each morning, a habit long recommended for treating sleep disorders.

-“In most modern environments, people are sleeping in a fixed temperature, even if it is reduced from daytime levels,” Siegel said. “It may well be that falling environmental temperature is integral to sleep control in humans.” The team was surprised to find that all three groups receive their maximal light exposure in the morning. This suggests that morning light may have the most important role in regulating mood and a group of neurons that serve as the brain’s clock. Morning light is uniquely effective in treating depression.

“Many of us may be suffering from the disruption of this ancient pattern,” Siegel said.

Here’s to getting a restful night’s sleep by following a regular lifestyle and a healthy diet!




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