TRANSCRIPT

Hello and welcome to another podcast from BNP Paribas Wealth Management with Edmund Shing, Chief Investment Officer.

In this podcast, as we've come to the end of April as of the time of recording, I want to talk about a simple investing system that you can execute yourself on a monthly basis and which has very encouraging long-term results. This is the idea of investing in stocks once a month at the end of each month, only if the stock market in question, let's say here the S&P 500 in the US, is within 5% of its 12-month high. So, at the end of every month, you say: what has been the highest level of this S&P 500 index in the last 12 months? In this case, the highest level of the S&P 500 index in the last 12 months has been 6,144 points. At the end of April, it looks like it's going to be around 5,477. So, you only have to ask yourself one question. Is the high less than 5% away from where you are today? The answer is actually no, you're more than 5% below the 12-month high. So, in this case, you would not buy the S&P 500 index for the next month, but instead for the next one month, you would invest in US government bonds.

Now, if you were to have executed this system between 1972 and 2019, and this is taking the data provided by Mebane Faber of Cambria Investments, who very kindly wrote a paper all about this model. Between 1972 and 2019, a so-called “switch model” that would switch between US stocks and bonds based on being within 5% of the 12-month high each month or not, would have provided a return of 11.7% per year on average over these 48 years, and with much better risk-return characteristics than simply buying and holding the S&P all the time.

So in the case of buying and holding the S&P all the time, over those 48 years, your maximum drawdown from peak to trough would have been minus 51% as achieved in 2008, whereas with this system, you would only have had a maximum drawdown of minus 23%, so less than half. So what I'm saying is with this system, applied to US stocks once a month at the end of every month, and just asking are you within 5% of the 12-month high on the S&P 500 index. Just using this very simple system to either buy equities for the next one month or buy bond exposure for the next one month, you achieved an average yearly return of 11.7% in US stocks with a much more limited drawdown.

And what's more interesting is you can apply this to a number of other assets as well, not just US stocks. So, in this case, Mebane Faber has also looked at foreign stocks, so that's everything outside of the US, largely Europe, Japan, and emerging markets. And this foreign stock grew as a whole, achieved in dollar terms at least, an average return over these 48 years between 1972 and 2019. They achieved an average total return per year of 13.7% so even better than for US stocks. And this compares to, if you had simply bought and held this foreign stock index, which is MSCI World ex-US, for the period between 1972 and 2019, you would achieve an annual average return of 9.4%. So 13.7% using this 5% away from 12-month average tactic once a month at the end of every month, as opposed to only 9.4% if you had bought and held the stocks all the time. And again, achieved at a much lower level of volatility and drawdown risk using this switch model than buy and hold.

Give you one other example, gold, which is very topical at the moment given that gold is so strong. If you were to have executed exactly the same system using gold between 1972 and 2019, you would have achieved 11.2% in this switch model holding either gold every month or US bonds if you were not within the 5% of the 12-month high in gold, had a much lower drawdown.

So in each case, whether you look at US stocks, foreign stocks or gold, you have had much better results over the long haul by following this system, which is very quick to implement. Just takes a couple of moments at the end of every month. You only have to measure one thing and it's a yes or no decision. And if you were to follow that blindly in a binary fashion, just buying either the stocks or switching into the bonds or buying the gold or indeed switching into the bonds, otherwise, you would have achieved much better long-term returns at much lower risk overall than just simply buying and holding throughout the whole period. So what does this mean today?

Well, if you were looking at the S&P 500, as I said, what would this say for the month of May? It would say don't buy stocks by instead bonds. For foreign stocks, if we use the MSCI World ex-US index in US dollars as a reference, you're actually only at the end of April, 1.7% below the 12-month high, which was actually registered in the middle of March.

So as regards foreign stocks for the month of May, you would indeed be a buyer of foreign stocks for the next month, which is a difference to the US. For gold, with gold at over still over $3,300 of an ounce at the time of recording at the end of April and the high being $3,410 an ounce, you would indeed continue to buy gold for the month of May. There you have it, a very simple system at the end of every month. Check your preferred asset class. Is it less than 5% below the 12-month high registered for that asset class? If yes, buy the asset class, US stocks, foreign stocks, gold, if not buy government bonds.

There you have it, strong performance from this system over time with much reduced drawdown and nothing particularly to worry about because it is a simple quantitative system without any subjective judgment necessary. There you go, the Mebane Faber switch model, which I think provides very interesting returns, something for you to consider when thinking about what to do in this very volatile environment.

Thank you very much for listening to this podcast from BNP Paribas Wealth Management. Please do like, share and subscribe to our series of podcasts and until the next time, thank you for listening and goodbye.