Sunday , 20 August 2017

S&P 500 is 45% Overvalued According to Reversion to Mean Analysis!

An Historical Look at Previous Secular Bull and Bear Markets

Was the March 2009 low the end of a secular bear market and the beginning of a secular bull? Without a crystal ball, we simply don’t know. One thing we can do is examine the past to broaden our understanding of the range of possibilities [so let’s do just that by looking at charts of the inflation-adjusted secular highs and lows and regressions to trend of  the S&P 500 from 1871 to the present so we can make some sense of it all]. Words: 682

So says Doug Short ( in paraphrased comments from an article* reformatted and edited […] below by Lorimer Wilson, editor of, for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. Short goes on to say: 

The Inflation-Adjusted Secular Highs and Lows of the S&P 500 Since 1871

The pattern of long-term alternations between up- and down-trends… [are called] “secular” bull and bear markets from the Latin word saeculum “long period of time”.

If we study the data underlying the chart above we can extract a number of interesting facts about these secular patterns:

The annualized rate of growth since 1871 is 1.97%. If that seems incredibly low, remember that the chart shows “real” price growth, excluding inflation and dividends. If we factor in the dividend yield, we get an annualized return of 6.64%. Yes, dividends make a difference. Unfortunately that has been less true during the past three decades than in earlier times. When we draw a regression through the data the slope is an even lower annualized rate of 1.71% [… and if we were to add in] the value lost from inflation, the “nominal” annualized return [would] come to 8.85% — the number commonly reported in the popular press. For an accurate view of the purchasing power of the dollar, however, we’ll stick to “real” numbers.

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Since that first trough in 1877 to the March 2009 low:

  • Secular bull gains totaled 2075% for an average of 415%.
  • Secular bear losses totaled -329% for an average of -65%.
  • Secular bull years total 80 versus 52 for the bears, a 60:40 ratio.

This last bullet probably comes as a surprise to many people. The finance industry and media have conditioned us to view every dip as a buying opportunity. If we realize that bear markets have accounted for about 40% of the past 122 years, we can better understand the two massive selloffs of the past decade. Based on the real S&P Composite monthly averages of daily closes, the S&P is 59% above the 2009 low, which is still 34% below the 2000 high.

The Inflation-Adjusted Regressions to Trend of  the S&P 500 Since 1871

When the regression trend line is drawn through the chart above it essentially divides the monthly values so that the total distance of the data points above the line equals the total distance below [the line and it is depicted in the chart below].

The slope of the line [above], an annualized rate of 1.71%, approximates the 1.97% annualized rate of growth since 1871 mentioned previously. The 0.26% difference is largely a result of the rally over the past 22 months.

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Regression to trend often means overshooting to the other side. The latest [available] monthly average of daily closes is 45% above trend after having fallen only 9% below trend in March of 2009. Previous bottoms were considerably further below trend.

[What] will the […next] bottom be? Only time will tell.


Editor’s Note:

  • The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
  • Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.
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