This week's posts will introduce rotation as an an altenative to rebalancing. Today's examples are for U.S. stock and bond markets dating back to 1919. Four investment strategies are applied to this 100-year period:
- 100% in the S&P 500, with dividends reinvested.
- 100% in 10-year Treasury bonds with interest reinvested.
- 60% in the S&P 500 and 40% in 10-year Treasuries. At the end of each month, either reinvest the income in its source or, if the percentage in stocks has drifted to 55% or 65%, then rebalance stocks and bonds to their respective targets.
- Either 100% in the S&P 500 or 100% in 10-year Treasuries, according to their recent performance, checked at the end of each month.
The next 25 years told a different story, as illustrated below. A sharp recession in the mid-1970's, followed by high inflation and high interest rates, then by prolonged rate cuts, combined overall to make the total return of bonds competitive with stock-returns. The strategy of 100-or-0 rotation responded in kind, allocating even-handedly, with an average stock-exposure of 53%. For the full 25 years, rotation beat all the other strategies, not by putting all its eggs in one basket, or by juggling two baskets at all times, but by opting periodically for the basket that better suited the changing financial environment.
- Beat 60-40 Rebalancing, every time
- Beat 100% invested in the S&P 500, three of four times
- Beat 100% placed in 10-year Treasuries, every time
- Beat inflation handily, for every 25-year period
In forthcoming posts, I'll continue this introduction to rotation as an investment strategy, examining questions like these:
- Using both raw returns and risk-adjusted metrics, how did rotation fare across 25-year periods and across countries?
- What about drawdowns, as in "flash-crashes" and major recessions? Did rotation handle them better than rebalancing?
- Is 100-or-0 the best way to do rotation, at all times and for all investors? Or would less drastic exchanges be better, depending on circumstances?