5 Lessons from 3 Lines in 1 Chart
$S&P 500(.SPX)$ $SPDR S&P 500 ETF Trust(SPY)$ $NASDAQ 100(NDX)$ $Invesco QQQ(QQQ)$ $Dow Jones(.DJI)$ $iShares Russell 2000 ETF(IWM)$
The chart below should be studied carefully by every student of the markets.
Here's my 5 thoughts from this chart:
1. Investor Behavior: everyone wants to own stocks at the top (when valuations are high), few want to own them at the bottom (when valuations are low).
2. There -is- An Alternative: the 1970’s-1980’s period saw a structural decline in stockmarket valuations (and allocations to stocks) and the alternative of double-digit interest rates played a massive role (if you can get doubled digit returns on cash with no risk that’s a better deal than risky stocks, also if you have a mortgage with a double digit interest rate it pays much better on a risk-adjusted basis to pay down debt than own risky stocks).
3. Secular Shifts Still See Cycles: throughout the secular macro/market regime shifts in this chart, you can still see clear cycles [Stockmarket: peaks and troughs in valuations, Economy: rise and decline in cash rates]. This is a good thing for cycle-aware active asset allocators (but also; beware that cycle peaks/troughs tend to be accentuated and extended around regime shifts).
4. Portfolio Drift is an Active Decision: if the value of your stock holdings go up relative to everything else you own, and you have not made any adjustments then you have let the market take your allocation/weighting to stocks up — this is an active decision because you could have decided to trim or rebalance. Most people don’t know they are making this decision.
5. Mean Reversion Happens Slow and Fast: valuations reverting back to the mean from cheap or expensive can be a very slow process (e.g. staying cheap from 1975 to 1985, or expensive from 1995 to 2000), but also a very fast process when it finally begins to happen (when the market peaks and rolls over it often drops faster than it climbed, and then the market bottoms it’s almost always also a rapid rebound from extreme fear).
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