The US market has surprised many, including seasoned market observers, in how quickly and strongly it recovered from the initial pandemic-driven selloff in March 2020 and, significantly, the absence of a correction (exceeding or even close to 10%) since. The S&P 500 has more than doubled from its pandemic lows — and has set 52 record closes along the way to its 20% gain so far this year.
Once again, US stocks have demonstrated remarkable resilience. The market bellwether Standard & Poor’s 500 index rebounded from the most recent bout of profit-taking to close at yet another all-time record high last Friday. That is not to say everyone is bullish. In fact, warnings of a major pullback from various quarters — analysts, prominent investors and market commentators — have been brewing for months, pointing to rising risks in high stock valuations, resurgence in Covid-19 cases due to the highly contagious Delta variant, hot inflation driven by logistics and supply chain bottlenecks and the resulting pressure on the US Federal Reserve to raise interest rates, mounting debts and so on. The obvious conclusion is that a correction must be imminent. Or is it?
We have a tendency to expect that markets will always, eventually, follow the path of reversion to mean. Currently, the S&P 500 is trading at 21 times forward earnings, well above the five-year average of 18.2 times and 10-year average of 16.3 times. Thus, a reversion to its historical longer-term averages implies that prices will fall. But such expectations are really driven by emotion. In fact, if you think about it, reversion to mean is a mathematical certainty but mean is not a static number. It is the moving average, and when the market is in a broader longterm uptrend, the mean is also rising.
