One Outlier to Another: The Market's Now at an Extreme

I ran across this great chart at The Sudden Debt Blog. It shows just how extreme the performance of the last 12 months has been. Not only did we overshoot the mean to an extreme March low, but we’re now sitting at an outlier point in terms of 6 month returns. While this mean reversion doesn’t necessarily mean the market will fall substantially, it is safe to assume that returns going forward will be nowhere near as high as they have been over the last 6 months:

One immediate observation is that the market has just swung from one near record (-40%) to another (+40%) between March and September 2009. Since 1871, only the Great Depression era exhibited greater swings in share prices.

How unusual is such an event, from a statistical standpoint? Let’s look at the next chart, a familiar distribution histogram (click to enlarge). The median 6-month performance is +3.1% (the mean is 2.7%) and the standard deviation around it (known as sigma, denoted by the Greek letter “σ”) is 12.2%.

Comments

[Tom Armistead:]

If you compute a ratio of the S&P 500 to either GDP or NIPA corporate profits and apply a similar line of reasoning as far as deviation and mean reversion, the result suggests the market is still on the low side of the mean.

That is not surprising because there a still a lot of negatives out there, but if you accept arguments based on reversion to the mean then net long high quality equities would be the way to go.

Nov 02 07:15 AM

[bartpr:]

i dont know what data you have referenced but the s&p.gdp ratio is the highest it has been for the few recent qtrs going back many years.
in fact it is the highest from the regression line of data in history.

Nov 02 08:08 AM

[doubleguns:]

That would be OVER a six sigma change. A near impossible event.

So now our politicians and wall street guru's can perform the impossible.

We should all feel safer and sleep much better at night.

NOT!!!!!!!!!

Nov 02 08:58 AM

[Ricard:]

"While this mean reversion doesn’t necessarily mean the market will fall substantially, **it is safe to assume that returns going forward will be nowhere near as high as they have been over the last 6 months**"

The key take I got was that perhaps this unusually steep recovery simply reverted to the mean from an even more unusual decline. We're still not near the 2007-2008 highs.

Nov 02 10:47 AM

[Roger Knights:]

"the market has just swung from one near record (-40%) to another (+40%) between March and September 2009. Since 1871, only the Great Depression era exhibited greater swings in share prices."

A widening gyre.

Nov 02 10:51 AM

[TotallyScrewed:]

Don't look now, but even higher earnings on a falling dollar are worth less than todays earnings - if there are any. Yet, the market seems pumped by a lower dollar on the logic (sic?) that it will take ever more dollars to buy these future earnings at todays multiples of earnings.

My conclusion is that there is no "pattern", there is no "logic", there is no "value" in a fiat economy where money buys influence and influence buy policy and policy keeps the big money growing at idiotic rates while everyone else suffers. The is not now nor has it ever been fair.

A full seventy percent of the fantastic March to October 2009 growth benefitted a handfull of investment houses (aka "banks" per Paulson) who use OUR MONEY to make billions for themselves then paid back the principal to avoid scrutiny. Whereas on the October 2008 and March 2009 downswings, these same investments houses received 100 cents on the dollar for their foolish debts using OUR MONEY to bail out their worst accounts such as Fannie Mae and AIG. Why isn't anybody pissed about this?

Nov 02 04:12 PM

[driftwood2:]

This line of reasoning makes no sense. If the market goes through an extreme event, it's more likely to go through another extreme event to revert to the mean. So and extreme is to be expected following the first extreme.

Nov 02 11:12 PM

[Albertarocks:]

On Nov 02 04:12 PM TotallyScrewed wrote:

>Why isn't anybody pissed about this?<

One thumbs up for your accurate assessment and way with words, and another thumbs up for your name.

Nov 02 11:52 PM

[tripleblack:]

I'm an artist, so sometimes when I see charts like this, I see events in the physical universe.

The old analogy of dropping a stone in water works for me. In this totally extraneous picture, the cycle will repeat for a while as the energy dissipates. Each subsequent wave front will see lower peaks and valleys.

The lack of high level LEARNING from the "unique events" IS distressing, though...

Now my picture includes hordes of angry people drowning in the waves...

Darn.

Nov 03 07:18 AM