O’Shaughnessy: Leverage Responsible for Downturn but Stocks are “Compelling”

In a recent Reuters article, James O’Shaughnessy, chief investment officer of O’Shaughnessy Asset Management, says that lofty amounts of leverage was one of the major reasons for the current bear market and recession. But, O’Shaughnessy said that “stocks are now at their most compelling valuations since 1982. And Wall Street can come back too, with a modicum of temperance.”

In September of this year, O’Shaughnessy wrote an excellent piece on this web site. The report, titled “The Only Thing We Have to Fear Is Fear Itself”, makes the argument that large stocks are due for some strong gains over the next 10-12 years. One of the key reasons is that stock returns revert to the mean, and over the last decade returns on large cap stocks have shown dismal performance. According to O’Shaughnessy’s research, large cap stocks could generate real returns of 8.5% to 12% between now and 2020. On the surface, it appears that O’Shaughnessy was a bit early on this bullish article given what happened to the market in October and November, although he makes it clear that he was not attempting to call the bottom of the market with the data included in the report.

The overall message that he drives home is that stock prices have always recovered from every major downturn and typically the best time to invest is when fear is at a climax.

The Growth/Value Investor portfolio run on Validea, which is based on O’Shaughnessy’s quantitative strategies, is the fifth best performing portfolio over the last five-and-a-half years. The portfolio has a total return since inception of 19% vs. an 11.2% loss for the S&P 500.