S and P 500 pushing the Envelope

This is from my recent post on talkmarkets.com:

Looking at the weekly close on the S and p 500 since 1950 its average close stands at 522 while the standard deviation stands at 606. One of the few markets in the world where the standard deviation exceeds the mean. This is also true with other US Indices like the Dow and the Nasdaq but is not the case with Emerging markets. This has been the case with US markets since 1998 when the FED intervened in the market to bail out the failing LTCM. Subsequent Fed intervention has caused the risk in the market to go up and not come down.

Taking this a step further looking at where we are now we are sitting at well over 3 standard deviations over the mean. Earlier situations like this produced corrections in excess of 15%. Lets take a look at some of them:

S and P 500 Returns from Peak at about 3 Standard Deviations above the Mean

Time	Standard Deviations above Mean	%Loss from Top
August 1987	4.57	33%
July 1998	4.93	18%
March 2000	4.63	26%
May 2001	3.20	25%
October 2007	2.84	56%
July 2015	3.04	16%

This is not to say the markets will start crashing tomorrow but given the insane valuations and the fact that we have not visited the long term average on the S and P 500 which stands at 522 since 1974, the risks are out there!

Chart of the Week - Cresmont P/E

The Chart of the week is courtesy Gary Gordon via seeking alpha  and shows the Cresmont P/E ratio of the S & P 500. The ratio is currently at well over 2 standard deviations over the mean much like in 1930, 2000, and 2008 when the market experienced substantial sell offs. Will it be any different this time around?

US Stock Market, Lots of Downside Ahead, Major Tops and Bottoms Analysis since 1950

With the recent melt down in global markets, it would be prudent to look back at historical data on the US market to see where we stand. To do this I look at major tops and bottoms in the S & P 500 obtained from weekly historical data from Yahoo Finance since 1950. The first table below shows major tops and bottoms in the S and P 500 relative to the average and standard deviation:

Table 1: S&P 500 Tops/Bottoms, Average & Standard Deviation over Time

Date	S & P 500 Top / Bottom	Average	Standard Deviation
November 25, 1968	108.37	55.37	24.92
May 18, 1970	72.25	58.26	26.21
January 2, 1973	119.87	62.90	28.12
September 30, 1974	62.34	65.38	28.78
December 22, 1980	136.57	72.26	29.69
August 2, 1982	103.71	74.74	31.00
August 17, 1987	335.9	90.93	53.55
30-Nov-87	223.92	92.37	55.95
13-Jul-98	1186.75	181.77	203.72
31-Aug-98	973.89	184.22	208.73
20-Mar-00	1527.46	218.64	282.52
2-Apr-01	1128.43	242.13	324.34
14-May-01	1291.96	244.38	327.45
10-Sep-01	965.8	250.33	334.93
11-Mar-02	1166.16	258.34	343.62
30-Sep-02	800.58	266.00	349.94
8-Oct-07	1561.8	346.50	427.52
2-Mar-09	683.38	366.81	443.71
19-Apr-10	1217.28	379.11	448.71
28-Jun-10	1022.58	381.39	449.82
2-May-11	1340.2	392.94	457.43
15-Aug-11	1123.53	397.09	460.40
13-Jul-15	2126.64	474.27	543.97

As can be seen in the table above on only one major bottom in 1974, the market tested it's long term average since 1950. We have not tested the average since 1974 for well over 40 years. The other interesting observation is that the standard deviation of the market has exceeded it's average since 1998 with the market way above its average. This coincides with the involvement of the FED in the market since 1998 post the Long Term Capital debacle and suggests that the risk in the market has increased significantly. The markets average since 1950 currently stands at about 475.

The next table shows the deviation from the average at major tops and bottoms and the return from highs to lows and lows to highs.  The market in its early stages till about 1987 always peaked out at about 2 standard deviations above the average. Since 1987 the market has gotten as high as 5 standard deviations above its long term average.  Bottoms tend to occur within 1.5 standard deviations from the average. Every key top at above 2 standard deviations from the mean produced a decline of at least 16%. The current market is the fourth most over extended market in history.

Table 2: No of Standard Deviations from the Average at Major S&P 500 Tops/Bottoms and Subsequent Returns from Tops to Bottoms and Bottoms to Tops

Date	No of Standard Deviations from Average	% Change
November 25, 1968	2.13	-33%
May 18, 1970	0.53	66%
January 2, 1973	2.03	-48%
September 30, 1974	-0.11	119%
December 22, 1980	2.17	-24%
August 2, 1982	0.93	224%
August 17, 1987	4.57	-33%
30-Nov-87	2.35	430%
13-Jul-98	4.93	-18%
31-Aug-98	3.78	57%
20-Mar-00	4.63	-26%
2-Apr-01	2.73	14%
14-May-01	3.20	-25%
10-Sep-01	2.14	21%
11-Mar-02	2.64	-31%
30-Sep-02	1.53	95%
8-Oct-07	2.84	-56%
2-Mar-09	0.71	78%
19-Apr-10	1.87	-16%
28-Jun-10	1.43	31%
2-May-11	2.07	-16%
15-Aug-11	1.58	89%
13-Jul-15	3.04	?

Finally drilling down to tops and bottoms since 2000, the average top to bottom decline since 2000 is 28% while the average bottom to top return since 2000 is 55%.

So the question begs what does it mean for today’s market? We have already started breaking down from over extended levels. The current market average is about 474 and standard deviation is 544. Here are some scenarios below:

Table 3: S&P 500 Possible Scenarios

Market Average (MA)+ Standard Deviation (SD)	S & P 500 Level
MA	474
MA +  1 SD	1018
MA + 2 SD	1562
MA +  3 SD	2106

The bottom line is folks we are historically over extended. We could now correct to at least 2 standard deviations above the long term average which is close to the 2008 highs near 1575 or to a standard deviation (#stdev) above the long term average as was the case at the 2008 lows near 1018 or to the long term average near 474 which we haven’t revisited since 1974. Only time will tell.

S and P 500 reversion to the mean ongoing? Analysis of major tops & bottoms http://t.co/Q6Uq65hgaW pic.twitter.com/a15iGR5LCx

— samuelR (@RajveerRawlin) September 7, 2015