Prior Bear Markets: A Poor Guide to Future Newsletter Performance

    by AAII Staff

    The stock bear market that began in October 2007 has been such a traumatic event in the lives of so many investors, that it is likely to dominate investment decision-making for years to come.

    Whether that’s a good thing, however, is an open question—I’m not so sure that it is.

    That’s because performance in bear markets is a poor guide as to how an adviser or strategy will perform over the long term. And this is true not only because the stock market historically has had an upward bias. It’s also because performance in one bear market is a poor guide to returns in subsequent bear markets.

    The Data

    I support these bold claims with reference to the Hulbert Financial Digest’s database of investment newsletter performance. That database, of course, contains returns independently calculated by the Hulbert Financial Digest (HFD), using its standard methodology.

    Key elements of that methodology include executing all model portfolio transactions on the days that subscribers could actually act on the newsletters’ advice, and debiting transaction costs such as bid-ask spreads and discount brokerage commissions. In addition, if a newsletter has more than one portfolio, then the HFD calculates a composite reflecting the average of its several portfolios, including those that may have been discontinued over the years.

    Let’s begin the discussion with the data in Table 1, which lists the top 10 newsletters on the HFD’s monitored list based on their performance during the 2007–2009 bear market.

    On average, these 10 newsletters produced a 4.3% annualized return during this bear market—in contrast to a 38.7% annualized loss for the overall stock market, as represented by the Dow Jones Wilshire 5000 total return index.

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    Now focus on how these 10 newsletters have fared historically. Over the last five and 10 years (through April 30), these newsletters on average are well ahead of the market—which is not surprising given the extent of their market-beating performance during the recent bear market. But notice that, even given their impressive returns in the recent bear market, they on average are behind the overall market for performance over the last 15 years and last 20 years.

    This pattern is not limited just to the top performers in the most recent bear market. Take a look at Table 2, which lists the top 10 performing newsletters during the 2000–2002 bear market.

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    Once again, these newsletters are ahead of the market over the last five- and 10-year periods, but they are behind a buy-and-hold position for performance over the last 15- and 20-year periods.

    Furthermore, many of the top performers in the 2000–2002 bear market did not acquit themselves very well in the 2007–2009 bear market. In other words, top performance during the 2000–2002 bear market was not a guarantee of performing well in the subsequent bear market.

    Lastly, take a look at Table 3, which lists the 10 newsletters with the best performance over the 10-year time period that ended with the stock market high in March 2000. Perhaps not surprisingly, given that this 10-year period was so bullish, these newsletters on average have not produced stellar returns over the last five- and 10-year periods (through April 30). On the other hand, over the last 20-year period these newsletters on average beat the market, coming out well ahead of the average for newsletters that came out on top during either of the last two bear markets.

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    The Bottom Line

    Given our recent trauma, most of us would readily accept a Faustian bargain to retroactively give up much of our bull market returns in order not to have lost so much in the bear market. But the data do not suggest that this is a rational trade-off.

    If history is any guide, you will be better off going with newsletters that have the best long-term returns, even if that means incurring sizeable bear market losses.

    It appears that it is more important to perform well during the bull markets than it is to perform well during the bear markets.

    In other words, the best thing we can do for our portfolios might be to forget that this bear market ever happened—as difficult a task as that might otherwise be.