Every season has its time, and the next one doesn’t look good for U.S. stocks.
The “Joseph Effect” says that the U.S. stock market will have a return that is below average over the next ten years, or even a loss.
Benoit Mandelbrot, a mathematician, came up with the idea of the “Joseph Effect.” It is based on the Bible story of Joseph, who had a dream that seven years of plenty would follow seven years of plenty. Mandelbrot discovered that above-average performance is likely to be followed by below-average performance in many areas, including the financial markets. The opposite is also true.
As you can see in the picture above, this trend is clear in the U.S. stock market. It shows the stock market’s average total return over the last 10 years, taking inflation into account. Look at how the 10-year returns on stocks go up and down. Don’t let your eyes fool you: There is a statistically significant negative 30.3% link between trailing-10 returns and forward-10 returns.
Know that the suggested prediction for the stock market by the Joseph Effect is not based on valuation or any of the other factors that market timers usually look at. It also has nothing to do with the stories that Wall Street is interested in. It is just based on the fact that times of plenty tend to be followed by times of lack, and vice versa.
Stay against what most people think.
This study shows how dangerous it is to guess what future returns will be like by extrapolating from the past. If you take this method, you might be most optimistic when you should be most pessimistic, and the other way around.
In a new study about what he called “lost decades,” co-head of GMO’s asset-allocation team Ben Inker made this point. During these times, the typical blend of 60% stocks and 40% bonds “either broke even relative to inflation or, even worse, lost money in real terms.” Inker says that since 1900, there have been six such times in the U.S., with an average length of eleven years between each one. To put it another way, half of the years since 1900 have been in one of these “lost decades.” *
That should be enough to wake you up, but there’s more. Inker found that the 60/40 portfolio had “all followed exceptionally strong periods of return” during these lost decades. This is known as the “Joseph Effect.” Inker figures that this stock has had a return about twice as high as its long-term average over the past ten years. This is why he thinks the next ten years will not be good.
None of this talk can be turned into short-term market trading tips. The Joseph Effect doesn’t help us figure out what the market will do along the way, even if the next ten years follow the trend of past tens and do worse than average. So, you shouldn’t try to pick a specific day to get out of stocks. Instead, you should gradually lower your equity exposure as the stock market’s trailing 10-year return rises above the long-term average. On the other hand, you should gradually increase your equity exposure as the market’s trailing return falls below average.
As so often, Warren Buffett said it best when he said that as investors, it’s our job to be scared when other people are greedy and to be greedy when other people are scared. That’s most likely why Berkshire Hathaway’s stock shot up.The amount of cash on hand is at an all-time high.
