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Mean Reversion: Index Risks & the ‘M7’
In the game of asset speculation – mean reversion suggests that over time an asset will eventually return to its average price if it drifts or spikes too far from that average level. If applied, it can often help you avoid paying too much. My thinking is the S&P 500 has now drifted too far from the longer-term mean. History has always told us that inevitably prices will mean revert. This post explores the potential risks to investors if simply choosing to passively invest via the benchmark Index. Look no further than the so-called “Mag 7” – which constitute more than a 30% weight.
Three Cheers for 5,000!
This week the S&P 500 closed above 5,000 for the first time. Another milestone as we climb the ‘wall of worry’. Over the past 100+ years the S&P 500 has averaged capital gains of ~8.5% per year plus dividends of ~2.0%. That’s a total return of close to 10.5% (on average). If you compound 10.5% per year over 20 years (i.e., ‘CAGR’) – that’s a 637% increase. But as we know, the pathway is rarely smooth. Some years the market may “add 20%” and others it could give back a similar margin (or worse). And we saw this happen recently. However over the long run – markets will rise more often than they fall.
Will the Bond Vigilantes Strike Back?
Last weekend Fed Chair Jay Powell gave a rare interview with TV program ’60 Minutes’. Not only did Powell tell people to expect rates to remain higher for longer – he also sent less than subtle warnings to Congress. I quote: “It’s probably time, or past time, to get back to an adult conversation among elected officials about getting the federal government back on a sustainable fiscal path”. Amen. But good luck with that Jay. When asked if this was an urgent problem – Powell said “You could say that it was urgent, yes.” In short, keep a close eye on bond yields – especially the long-end. The market wants them to head lower – much lower – however fiscal recklessness could prove otherwise.
Yields Rally on “Strong” Jobs Data
According to the BLS – we saw the strongest employment growth in 12 months alongside the fastest wage growth in 22 months (0.6% MoM). However, we also saw the lowest amount of weekly hours worked since 2010. Given the better than expect jobs gains and acceleration in wages (which remains well above the Fed’s objective) – it seems less likely the Fed can justify rate cuts in March. Probabilities for a cut in 2 months stand at 38%. This was above 70% just a month ago.