S&P500 Mean Reversion Model
As of September 30, 2024, the S&P500 is currently trading 71% above its modern-era historical trend value, (about 2.0 standard deviations ), indicating that the market is Strongly Overvalued .
This is a basic model based on a fitted exponential growth rate for the S&P500. To continuously stay above the trend line suggests that the stock market must continue to grow at a continuously higher growth rate . Such explosive growth is not sustainable over long periods.
Mean reversion, the basic principal that what goes up must come down, is a commonly held belief among market participants. While the daily movements of the stock market may be chaotic and unpredictable, long-term stock market returns tend to follow a somewhat predictable upward trend. Deviations from this trend can last for extended periods, even decades. As such, mean reversion is not an effective strategy for short-term trading but rather a useful indicator of overall market valuation relative to historical trends.
We use S&P500 daily close data, available from Yahoo Finance back to 1950. This data is not inflation adjusted, so we index it to current dollars using CPI data from the US Bureau of Labor Statistics. One could just as easily use other broad market indices (Russell 2000, Wilshire 5000) and get very similar results, though the S&P500 data is the most easily available and likly to be familiar to most investors. The data is shown below, along with an exponential regression line showing the trend over time.
