Many investment strategies are based on the implicit assumption that the future will mirror the past. From quantitative evaluation, back-testing trading strategies against historical market performance, to investors who are overweight, for example, bank stocks or real estate, because they have always performed well for them in the past. Both include the implicit assumption that future performance will mirror the past.
This often means that new opportunities are missed and old investment stalwarts held long after their time has passed. Technology stocks were shunned by many conservative investors, most notably Warren Buffett, for decades as there was little past history to evaluate them by. And past market dominance can be disrupted by new technologies: traditional news media have lost a large portion of their advertising revenue to online competitors, high street retailers are losing ground to online competitors, and the oil and gas industry faces a long-term threat from renewable energy.
Investment strategy should be based on the future as well as the past. Past history may provide a solid base for projecting future performance but it is no guarantee. While we cannot foresee the future, evaluation of existing trends will help us to map out a broad framework on which to base our investment strategy.
Identification of developing trends will help us to avoid some of the pitfalls and take advantage of new opportunities as they unfold.
Structural (or secular) trends are long-term trends spanning several decades; sometimes even centuries. Some obvious examples:
Ageing Populations in Developed Countries
Growing Populations in Undeveloped Countries
Global Land-Ocean Temperature Index
Data source: NASA’s Goddard Institute for Space Studies (GISS).
And the Rising Impact of Technology
Cyclical trends tend to reverse direction more frequently, with a peak-to-peak cycle of several years. The interest rate cycle, commodity prices and exchange rates are typical examples.
Stock market cycles are influenced by external shocks as well as structural and cyclical trends. We do not have a crystal ball and cannot foretell external shocks such as wars and natural disasters but they should not be ignored. The best we can do is evaluate known risks and attempt to build this into our framework. Unknown risks or ‘fat tail’ events — with low probability but devastating impact — are unfathomable and must be accepted as part of the uncertainty we live with in our daily lives. However, we should also monitor macroeconomic and volatility filters to alert us to changing market conditions as external shocks may build over time.
Over the next few months I will map out major structural and cyclical trends and attempt to evaluate their impact on different asset classes. External threats to our global economy and macroeconomic and volatility filters, warning of market risk, are regularly covered in my weekly newsletters.