Unchartered Territory

The inflation-adjusted S&P 500 index price was 170 percent above its long-term trend at the end of April, up from 158 percent the previous month.

In the stock market, the one certainty is that overperformance eventually turns into underperformance, and vice versa. Is this movement following a pattern?

Let’s look at the question using some basic regression analysis.

The chart below shows the S&P Composite since 1871, using the real (inflation-adjusted) monthly average of daily closing.

Regardless of the index price range, we’re utilizing a semi-log scale to equalize vertical distances for the same % change.

The secular pattern of deviation from the trend — those multi-year periods when the market trades above and below trend — is clarified by the regression trendline formed through the data.

That regression slope, by the way, corresponds to a 1.88 percent yearly growth rate.

The peak in 2000 was a historic 129 percent overshoot of the trend, much exceeding the 1929 overshoot.

With one exception: a brief fall of around 15% below trend in March 2009, the index has been above trend for two decades.

It is 170 percent over trend as of the beginning of May 2021.

In the past, big troughs saw drops of more than 50% below the trend.

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