Reader Mail: Additional Research & Inflation

Can you pleases give more details on this study that was done by London Business School? Perhaps include a link in tomorrow’s DR.

You know us DR readers are thirsty for knowledge. You can’t simply throw in a few lines that confirms that “the trend is your friend”, when the whole premise of DR is not to invest that way. You have an obligation to address their research, or give us the information so that we can do so ourselves.


Okay. Here you go:

Research away George!

For the record, the survey concluded that, “Using data on the UK’s 100 largest stocks since 1900, the team created two portfolios, one based on the 20 best-performing equities in the previous 12 months and the other the 20 worst performers. These portfolios were then re-calculated every month. The portfolio of winners produced compound annual returns of 15.2 per cent, turning £1 into more than £4.2m (€5.6m, $8.2m) by the end of 2007. In contrast, the portfolio of laggards returned just 4.5 per cent a year, turning £1 into £111.”

Does that really mean the trend is your friend? Is their a survivorship bias? Do objects in motion tend to stay in motion while objects at rest tend to stay at rest?

The study’s author Professor Paul Marsh says, “It is a very simple strategy, buying winners and selling losers. In a well functioning market it ought not to work… We remain puzzled and we are not the only ones; most academics are vaguely embarrassed about this.”

Some other interesting images from the study below. First, oil, industrial metals, mining and tobacco have done well in the last seven years. There are lots of miners taking smoke breaks, apparently. The worst world sectors are all the same things that led the tech boom. Keep that in mind when considering Aussie banks. The stocks that led the recent boom in finance will probably not lead the next boom… because the next boom is not going to be in finance.

Mining Boom Replaces Tech Boom
Mining Boom Replaces Tech Boom

Second, check out Australia leading all countries with a 7.9% annual return on equities since 1900. That probably includes reinvested dividends. And it probably is a testament that the 20th century was the age of industrialization, which favors Australia’s publicly listed resource stocks.

Return on Equities Australia

Finally, if you think the last few months have been horrible, think again. We’ve had corrections. We’ve had volatility. But we haven’t had anything like the shocking periods portrayed below… at least not yet. Will 2008 be added to the list, and where will the crash hit hardest… .the UK? The US? China?

Where will the crash hit next

And time for one more.

To the Editor,

Dear Sir,

If Inflation is caused by too much money, then surely the cure is to reduce the amount of it, rather than make it cost more?

Clement C.

P.S.: Of course the banks would squeal as they are only interested in creating lots of it, and charging interest on what they make from thin air.

Right you are Sir, more or less. Central banks can reduce the quantity of money in circulation if they really want to. But it’s highly unlikely. The way to reduce the growth in the money supply is to raise the price of money, which is just what the RBA has done. All other things being equal, rising prices equate to slowing demand. It goes for money as well as banana bread.

As for the banks? Well, the whole exercise in fractional reserve banking requires the willing suspension of disbelief by everyone who participates in the system. Money is created out of thin air, as you say, based on deposits held by banks. The system works because we have faith in it… and we don’t all go asking for our money at the same time.

The moment may come when people lose their faith in the government’s money or their confidence in the security of bank deposits. But we haven’t reached that moment yet.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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