Thursday, September 17, 2009

A history of mean reversion

Following is a chart of the All Ordinaries from 1984 to the present with the 50 day and 200 day simple moving averages overlayed:

And here is a look at these same moving averages from a slightly different perspective - it's a chart mapping the percentage difference between the All Ordinaries and these moving averages over time:

A couple of conclusions from these charts:
1) By this measure, March of this year was an absolute bargain.
2) We have now reached the other end of the spectrum where the market is trading over 10% above the 200 day MA.  This doesn't happen often - and when it has (1987 pre-crash and then the post crash bounce and 1993 before interest rates got ratcheted up) the market has had some sort of pullback in the near term.
3) The flipside to this is that part of the 'mean reversion' is that the mean itself starts coming up to meet the market.

On the evidence of 1987, we could conclude that the market will probably correct from today's levels, but another crash is not in the making.  It is more likely that the market will trade broadly sideways for the forseeable future.

One big difference between 1987 and now that could change this dynamic is that interest rates were an effective policy tool back then.  Global interest rates plummeted post the crash and this kicked off a round of asset price inflation (that ultimately lead to our home grown property bubble).  Will this work this time?  Probably not - that is why central banks around the world are doing the QE two-step.  On the evidence of the repricing of risk assets this does seem to be working.  As we've noted before the real test is about to unfold as the QE is taken out of the system...

Finally, had a quick look at the (even) longer term.  Following is a chart of the All Ordinaries (in log format) from 1875:

And the difference between the monthly average above and the rolling 12 month simple average of this average (sorry but it was the best I could do).

Speaks for itself really...

1 comment:

  1. Confirmation bias: ln what has been an almost unprecedented move, the S&P 500 closed more than 20% above its 200-day moving average Wednesday for the first time since May 1983.