How to Build a Portfolio That Outperforms For a Century

Tracy Alloway (0:11)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. My co-host, Joe Weisenthal, couldn't make it today.

So I'm looking at a chart of the S&P 500, and let's see, it's almost exactly one year post the big dip in the S&P 500, the massive crash that we saw back in March of 2020 And of course, we've seen risk assets come roaring back.

But with the recovery in financial assets, we have a lot of questions over how long can this continue? Are we on the verge of some sort of big change in the market as central banks unleash fiscal stimulus and interest rates remain at or close to the zero bound? Are we going to get inflation? Are we going to get stagflation?

Are we going to see perhaps even deflation? Is there any way we're ever going to get out of this regime of low inflation? And I think whenever we have these big turning points in markets or when we have lots of people talking about the potential for big turning points in markets, we also have a lot of opinions on how those are going to go and what type of portfolio would perform best. And of course, we've seen a lot of handwringing recently around growth versus value, 60-40, what happens when both bonds and stocks fall at the same time. So on today's show, we're going to be discussing exactly this idea. How do you build a portfolio that can withstand these regime changes and basically outperform over a really long time horizon? And I'm excited to say our guest for this episode is Chris Cole, the founder of Artemis Capital. He's appeared on Odd Lots previously, digging deep into the low volatility regime of the past years. It's great to have him back. He publishes some excellent research. Chris, thanks for coming on the show again.

Chris Cole (2:17)

Thanks, Tracy. It's great to be back on the show.

Tracy Alloway (2:20)

So I guess my first question is, the reason we're having this discussion is you published a paper called The Allegory of the Hawk and Serpent, How to Grow and Protect Wealth for 100 Years. Now, most investors aren't really looking at their portfolios on a 100-year basis.

What sparked your interest in that kind of timeframe?

Chris Cole (2:44)

Well, what's really interesting about, in particular, the last 40 years, is that there's a tremendous recency bias that market participants have. The last 40 years are incredibly unusual, comparative to overall history.

And I believe, as I make the case in the paper, that recency bias is now a systemic risk.

91% of the price appreciation for a classic 60-40 portfolio over the last 93 years has come from just the 22 years between 1984 to 2007 So what we've had is this incredible outperformance of both stocks and bonds that has been from a reinforcing cycle. And we use the allegory of the serpent for that. And that's been led by falling interest rates. Rates fell from 17% to 0%. There's been incredible favorable demographics as baby boomers have come into the workforce. Falling taxes, taxes have fallen to near 100-year lows, globalization, unprecedented monetary policy. And we now have some of the highest levels of both government and corporate debt in American history. So as a result of this, there's been this incredible outperformance of stocks and bonds over the last 40 years. But the trillion dollar question that I think is important for any allocator is, is this repeatable?

And I actually believe that the factors that drove this generational boom in stocks and bonds are now reversing. We're now in a framework where debt's at all time highs, the middle class hasn't seen real wage growth since the 1970s, and demographics are really poor and interest rates can't go any lower. So investors expecting the gains the last 40 years are likely to be extremely disappointed. And so to kind of understand what the next 20 years are gonna look like and how to build a portfolio that will last and can manage through this period of secular change, what I did is I went back through history and I recreated all of these financial engineering strategies using, I think, defensible assumptions over the last 93 years. And we know that history doesn't repeat, but it rhymes. And my goal was to figure out what portfolio can consistently perform to every market cycle, whether it's secular growth, whether it's inflation, whether it's deflation. And I think I came up with some really interesting answers in my paper last year, in the follow-up paper that I just released, that really answers the questions as to what type of portfolio really sustains wealth and capital appreciation and limits drawdowns. And the answer that I got is radically different from the type of portfolio that many institutions and retail investors are currently allocating to.