Economic Schools of Thought and Market Performance – Part Deux

In a previous post I put together a hypothetical benchmark global portfolio so we could take different economic schools and analyze how they might have helped us navigate the current bull market.  I want to continue the series today.  As a reminder, here’s the benchmark allocation and performance:

US Stocks: 20%

Foreign Stocks: 20%

REITs: 5%

Corporate Bonds: 19%

US Govt Bonds: 29%

High Yield bonds: 2%

Global Bonds: 3%

TIPS: 2%

CAGR: 9.7%

Standard Deviation: 3

Sharpe Ratio: 3.13

So, next up – the Behavioral Economists.  This was more difficult to allocate because they don’t make a huge number of market prognostications, but I think this is a good approximation:

US VALUE Stocks: 20% – Behavioralists like Robert Shiller have favored equities for much of the ride higher with a tilt towards value arguing that many segments of the market are overvalued.

Foreign Stocks: 20%

REITs: 0% – Behavioralists like Shiller have generally been bearish on housing since the recovery.

Corporate Bonds: 19% –  Shiller has stated on several occasions that the bond market is not in a bubble and is instead rallying because of the Fed’s forced flight to income earning instruments.

US Govt Bonds: 29% –  See above.

High Yield bonds: 2% – See above.

Global Bonds: 3% – See above.

TIPS: 7% – Shiller has stated his bullishness of TIPS in recent years.

CAGR: 8.7%

Standard Deviation: 1.5

Sharpe Ratio: 5.5

Shiller and the behavioralists kill it.  Although they reduce the return of the benchmark by 1% per year they substantially increase the risk adjusted returns.  Using vague macro commentaries from Shiller appears to have led to a decent asset allocation over the last 5 years.  Behavioral finance helps.

Next up, Market Monetarists.  The Market Monetarists have had a pretty good track record over the last 5 years.  They’ve repeatedly stated that inflation would remain low and their “Chief Economist” Scott Sumner has repeatedly discussed his general belief in owning a diversified stock portfolio.  Of course, that works great in a bull market and we’re not analyzing the bear market here so there’s that.  Anyhow, here’s the rough approximation:

US Stocks: 40% – Scott Sumner wasn’t just bullish about US stocks.  He begged and pleaded for the Fed to create a stock market bubble in 2009.

Foreign Stocks: 0% – QE was super bullish for US stocks so why go into foreign markets?

REITs: 0%

Corporate Bonds: 24% – Sumner has explicitly recommended that the US government buy AAA rated bonds.  Plus, MMers have said inflation and rates are likely to remain low over the last 5 years.

US Govt Bonds: 0% – Fiscal policy is a “bad idea” according to Sumner and can have unintended consequences.  Skepticism over government spending would lead them to be bearish.

High Yield bonds: 31% – Just guessing here, but the portfolio reallocation effect of QE would have led MMers to be bullish on high yield bonds.

Global Bonds: 3%

TIPS: 2%

CAGR: 12.6%

Standard Deviation: 5.3

Sharpe Ratio: 2.3

Sumner and the MM guys put up some good numbers here.  Their bullishness on stocks sets them apart in the nominal return category, but their risk adjusted returns suffer a little bit from being overly allocated in assets that are all highly correlated.  As a result their risk adjusted returns aren’t as good as the behavioral economists, but their CAGR outpaces them by a pretty wide margin.

Tomorrow we’ll touch on the New Keynesians and the Post-Keynesians, but that’s all the time I have for today.