#87: Reversion to the Mean

micksonmatch
June 25, 2024

S2N Spotlight

I want to share a pretty complex concept simply. It is often overlooked, as people prefer to go with the crowd—the cool kids.

If you take all the S&P 500 annual returns from 1928 to 2024, you will get an average annual return of 7.61%. Remember that number; it is important. I have drawn a red dotted line to help you see it visually. I think we can all agree that the blue dots are somewhat evenly distributed above and below the average. There are only a handful of years that are almost average near the red dotted line; the rest are above and below. The red line is like an anchor; it doesn’t allow the blue dots to run too far away.

I want to take the idea I presented above and present it in 5-year rolling averages. So every year, on a rolling yearly basis, I calculate the 5-year return and then calculate the average annual return so that we can compare it to the average return I asked you to remember, 7.61%, in case you forgot.

You can see that the rolling 5-year average annual returns have been pretty high over the last few years. What does that mean? It means that in order for the S&P 500 to fall in line with its 100-year history, it will need to underperform considerably. It can do it quickly with a steep drop or it can do it with prolonged underperformance; there is simply no way of knowing in advance.

One last chart, using 10-year rolling averages, helps present a picture of outperformance for long periods of time. It is financial physics that we will have to underperform in the future. My best guess is sooner rather than later.

S2N Observations

Have you heard of Bobby Jain? Don’t worry about it; neither have I. It turns out he has raised the biggest hedge fund debut since 2018 with $5.3 billion. He is an ex-Millennium; all 3 of the biggest debuts have been from Millennium alumni. Izzy Englander, the founder of Millennium, is still one of the kings in this industry, with more than $60 billion under management. For those not familiar with his model, he basically takes care of all the capital, and hedge fund stars run their own hedge fund pods under his Millennium infrastructure. Jain apparently was looking to raise $10 billion. He cut his fees to get the $5.3 billion over the line.

Nvidia is starting to look a little weaker than we have seen for some time. We really need to keep an eye on this stock, as it is such a large percentage of the overall weight of the indexes it comprises. I am pretty sure that at the end of this quarter, there will be some increase in the weighting of the index, which will likely provide some buying power.