Since 1928, the highest source of real returns in any asset class by far has come from the stock market. This is true in spite of the Great Depression of 1929 through 1933 and in spite of the 13 recessions thereafter. Through wars, disasters and political turmoil, stocks have been the best vehicle to not only keep up with inflation but far surpass it.

The tremendous wealth generation from stocks over this period, averaging over 9% annualized returns, makes a buy and hold strategy of the S&P 500 extremely difficult to beat. Beyond this, the Efficient Market Hypothesis maintains that it is impossible to consistently outperform the market while Random Walk theory asserts using technical indicators is futile. Finally, the CAPM states that the only way to achieve a higher return is to take more risk.

In our new research paper, “Leverage for the Long Run” (click here to download the full paper), we challenge each of these theories.

First, we illustrate that Moving Averages and trends contain important information about future volatility and the propensity for streaks in performance.

Next, we show that using Moving Averages to time the market achieves a similar to higher return with less risk.

Table 6: Unleveraged Buy and Hold versus Unleveraged Moving Average Timing

(October 1928 – October 2015)

Lastly, we show Leverage Rotation Strategies (LRS) which use a systematic rule to consistently outperform the market over time.

The key to this outperformance is understanding the conditions that help and hurt leverage in the long term. We show that it is volatility and seesawing market action which is most harmful to leverage.

Table 3: S&P 500 vs. Daily Leveraged S&P 500 – Path Dependency, Volatility and Leverage

On the other hand, low volatility periods with positive streaks in performance are most helpful. Moving Averages are one way of systematically identifying these conditions.

When the stock market is in an uptrend (above its Moving Average), conditions favor leverage as volatility declines and there are more positive streaks in performance. When the stock market is in a downtrend (below its Moving Average), the opposite is true as volatility tends to rise.

We found that being exposed to equities with leverage in an uptrend and rotating into risk-free Treasury bills in a downtrend can lead to significant outperformance over time. For investors and traders seeking a destination with higher returns who are willing to take more risk at the right time, systematic leverage for the long run is one way of moving there, on average.

We were humbled and honored to receive the 2016 Charles H. Dow Award for this research. The full paper is now available on the Social Science Research Network (SSRN): click here.