Irrational Exuberance Meets Secular Stagnation (4)

Historical Stock PricesThe Nasdaq-100 Index includes 100 of the largest domestic and international non-financial securities listed on the Nasdaq Stock Market based on market capitalization. I hope you both understand that with a ranking/rotation based system that operates on a static basket of vehicles (that pay dividends and cap gains), your system will generate different back test results every month that you test your system when you use adjusted data. I challenge you both to run a rotation/ranking system on the last day of each month starting this month, and to write down the score/rank for each of the vehicles in your basket, along with the closing price…use buy-on-close orders…on the last day of each month.

So unless you can demonstrate that backtesting a model on adjusted close prices has a negative effect when placing live orders at the real time price or makes a backtest model extra prone to failure in real time, I fail to see what the alarm is for anything other than relative ranking schemes. If my ranking system is using this adjusted data, then I am not using actual prices that I could have received in real trading. More importantly, with every new dividend/cap gain payout the adjusted prices time series will change.

However, if I were to use a momentum measure for ranking (e.g. 6 month returns), adjusted data is fine. What I have seen several times is this: I receive a signal one month to enter a certain fund, say FLVCX. The next month when the next rotation signal is generated, the system indicates that I should have been holding a different fund in the prior month, FSCHX.Historical Stock Prices

In the original 100 Years of Stock Market History post we noticed that the stock market sometimes appears to get ahead of itself. Periodically, prices reach a peak that is not permanently surpassed until decades later. For lists of other popular posts and an index of stock market posts, by subject area, see the sidebar to the left. As I mention periodically, my stock market returns are indeed hypothetical – theoretical.

In other words; when stock market advocates praise the returns of the market with reinvested dividends, if one were able to hypothetically invest in 1900, and they tout today’s returns it is a bit of a lie. To provide a sense of the interplay between the risk free rate and the equity risk premium, I plot the expected return on stocks (based upon future cash flows and current stock prices), decomposed into the equity risk premium and the and the risk free rate each year from 1962 to 2012. Hence, the link between the composition of the expected returns and stock levels.

Historical Stock Prices