Persistent Trends or Mean Reversion in markets

Sometimes markets trend for a long time; If that is the case the traders best strategy is follow the trend. As the old Wall Street saw has it, “the trend is your friend.”

The trend can last a very long time. For the last fifteen years, the primary trend has been that of rising US stocks. As the chart above shows, the last 15 years period (2010- 2024) has been the best such period since 1970. Investors who were long US stocks have done very well.

The longer a trend persists, the more out of whack valuation measures get. If a stock market is trading strongly higher, stocks get steadily more expensive on various measures. They start to look expensive relative to other markets, other assets or their own historical levels.

The market trend will have its own momentum and will continue to rise higher as the fear of missing out (FOMO) brings new investors and their capital not the market.

Some people ( value investors?) look at valuations and can’t believe what they are seeing. They may be tempted to take profits and go into cash. The bold ones may be tempted to sort the market. However, if the FOMO momentum is strong, shorting will be a catastrophic strategy. As the English Economist, Lord Keynes, noted “the market can stay irrational longer than you can say solvent.”

In January 2025, we put out two notes saying the US stock market was overvalued and we were worried about the impact of rising bond yields and the inflationary impact of the tariffs proposed by the incoming new President of the USA. The markets rose for another week and it was reported that the value of the US stock market had reached 70% of the global stock market capitalisation. This was a new high. However, the US stock markets have corrected in the six weeks since then

Recent data suggest the US economy is slowing, and markets view the manner of the implementation of tariffs and other economic policies as a source of political instability in the USA. The dollar has been falling and US stocks have come under pressure. The rally that followed the inauguration of President Trump has been erased.

Perhaps the near three decade long trend in favour of US stocks has come to an end and we are now in for period of mean reversion.

We were too focused on the US market and took out eye on the ball. Europe had underperformed for so long. Often the joke was it was a great place to go on holiday but not for investment. We probably said and wrote something similar. For a long time it was right. But perhaps nothing lasts forever – eventually everything reverts to the mean.

While US stocks had outperformed for 15 years. European UK stocks had underperformed for even longer. In 2025 so far mean reversion has happened.

As the chart above shows, so far this year (and we are only in early March) Germany is up 21%. Italy 18.7%, France 17% and even UK is up 12%. The US is down 0.5%.

This was something we have missed completely.

6/03/2025