I posted the following on Twitter this week:
It’s turning into another banner year for the U.S. stock market (so far).
Here’s a good follow-up question on these numbers:
This is a legitimate concern.
Since 2020 the S&P 500 has compounded at more than 14% per year. That’s not just a pandemic phenomenon either. Since the start of 2009, the S&P 500 has seen returns of 14.5% per year.
From the bottom in early March 2009, the S&P is up nearly 17% per year.1
Trees don’t grow to the sky. Above-average returns are followed by below-average returns, and vice versa. That’s how averages work.
The U.S. stock market can’t keep this up forever. Mean reversion will rear its ugly head eventually…right?
I’m confident this will happen at some point. Markets are always and forever cyclical because the economy is cyclical and human nature is cyclical.
Peter Bernstein has an excellent chapter on the challenges of mean reversion in his classic book about risk, Against the Gods:
Regression to the mean provides many decision-making systems with their philosophical underpinnings. And for good reason. There are few occasions in life when the large are likely to become infinitely large or when the small are likely to become infinitely small. Trees never reach the sky. When we are tempted–as we so often are–to extrapolate past trends into the future, we should remember Galton’s peapods. Yet if regression to the mean follows such a constant pattern, why is forecasting such a frustrating activity? Why can’t we all be as prescient as Joseph in his dealings with Pharaoh? The simplest answer is that the forces at work in nature are not the same as the forces at work in the human psyche. The accuracy of most forecasts depends on decisions being made by