#61 S2N: Rolling in it

S2N Spotlight

Yesterday, I said a new all-time high for the SP500 was a pretty sure thing. Well, we didn’t have to wait long. The markets made their 23rd ATH of the year, along with the Nasdaq and other US indices.

I wanted to create a visualisation that gives you a macro look at the SP500 returns over a fairly long time, around 100 years. The chart below looks simple but actually has quite a lot of information in it. I have made the blue line a rolling 10-year average return of the SP500. The current 10-year average return is 17.99%, and the mean of all the 10-year average returns is 10.92%. This means that we are currently above average when looking at long-term returns. I am working with daily data, which means that you could pick any time over the last 100 years, and if you held it for 10 years, you would have earned on average 10.92 per year for those 10 years. I added to the chart the average 1-year return, which is 7.91%. The simple but clear message is that investing for the long term is your best investment. The other clear message is that you can see very clearly that returns are mean-reverting. That means that when you have a cycle of returns above the mean, they will need to drop below the mean, and eventually they will need to rally above the mean again, and so the cycle goes. This is actually a good segue to inflation.

S2N Observations

As a market observer, it can seem childish how on Tuesday the market interprets the PPI inflation number as negative (mainly because of an adjustment to the previous month) and the next day a CPI print inline with expectations is interpreted as positive.

In the chart below, I have added a few extra pieces of information to help make things clearer. I am actually angry with myself. I have been saying over the last week: Stop the hysteria around inflation; we are sitting around the mean. This is actually true. I have added the mean headline and core inflation to the chart, and we are pretty much slap bang on the means. This was my mistake I was simply looking at the chart and looking at the long history of inflation.

The Federal Reserve officially adopted a 2% inflation target on January 25, 2012. This target was announced as part of the Federal Open Market Committee’s (FOMC) statement on longer-run goals and monetary policy strategy. The goal was to provide a clear and measurable objective to guide monetary policy and help anchor inflation expectations.

With this in mind, I have added a solid black line to mark the 2% inflation target set by the Fed. Core inflation is currently 3.62%; that is still a long way from 2%. I have also included a chart of the 5 and 10-year inflation expectations according to the bond market. I think all surprises will be to the upside I am afraid.

The next chart shows the number of stocks in the S&P 500 that are trading above their 200-day moving average. We loop through all 500 stocks in the SP500 and count which ones are above their 200-day moving average, as represented by the green line. Yesterday, we hit 80% of the stocks in the SP500 that are trading above their 200-day. This points to a very broad-based rally; the average number is plotted with the dotted line around 60%.

If you think that is bullish then let me help inform you. I have backtested buying the market every time the 200-day average index for the SP500 is above 80%, and it produces a Sharpe ratio of 0.38 versus 0.59 for buying and holding. If you are a medium- to long-term investor, then this is not a good signal to buy the market.

Finally, Dr Copper supposedly makes new all-time highs. To be honest, I am not sure exactly how to call this. For the more technical follower, I usually follow the continuous back-adjusted future price on my charts, which never registered all-time highs. I couldn’t understand why some of the market commentators were registering the ATH on copper, so I played around with my data and produced the new high. Putting the technicalities aside, this is not a good sign for inflation if history is anything to go by.

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