Last week, the
term ‘Easy Money’ conjured both comedian Rodney Dangerfield and the U.S. Federal
Reserve, and no one was certain how much respect either one should get.
The Fed
accidentally e-mailed its market-moving Federal Open Market Committee (FOMC)
meeting minutes to congressional staffers and trade lobbyists on Tuesday at 2
p.m. The minutes weren’t supposed to be released to anyone until Wednesday at
two. Once the mistake was realized, the Fed released the minutes early on Wednesday
morning.
Markets
enthusiastically embraced the minutes which appeared to focus on the idea quantitative
easing will continue. The Dow Jones Industrial Average closed at a record high more
than once last week, and the Standard & Poor’s 500 Index is already nearing
analyst’s targets for the full year.
The minutes
indicated committee members were less clear on the issue, according to the
Washington Post, which reported:
“A few Fed officials think QE (Quantitative Easing)
should be stopped immediately; a few think it should be shrunk fairly soon;
many think it should be slowed if we see a rebounding job market; a few think
it should continue at its current size until the end of the year; and a couple
think it may need to be increased. The minutes also make clear Fed officials
are not all on the same page in determining the economic climate that would
trigger that tapering.”
Committee members
are not the only ones who don’t know what to think about the economy. Consumer
sentiment has been volatile. According to The
Wall Street Journal, the Thomson-Reuters/University of Michigan consumer
sentiment index showed consumer sentiment improved significantly from mid- to
late-March only to decline again from late-March to mid-April. Bloomberg.com speculated
weaker consumer sentiment may have been the result of the payroll tax rollback
and weaker U.S. economic data.
It has been
said stock market returns revert to the mean, but what does
that mean? Reversion to the mean is a statistical phenomenon. It’s the idea the
further something is from the mean – or average – the more likely it is the
next thing that comes along will be closer to the mean. For example, if a
baseball player has a batting average of .330 and hits .180 in a game, it’s
likely that player will hit better in the next game (unless, the player’s in a
slump, but that is a different topic).
Reversion to the
mean is the theory behind a variety of investment strategies. Analysts who
employ the theory may look at an average price, an average return, or another
financial statistic they find relevant. For example, they may consider whether a
company’s recent performance varies significantly from its historical average
performance. If its performance is worse than average, some analysts may decide
the company’s price is likely to revert to the mean. In that case, they may
choose to invest in the company. If the company’s performance is better than
average, analysts may decide to sell shares. Similarly, if a market or index – such
as the U.S. Treasury market or the Standard & Poor’s 500 Index – performs
significantly worse than its mean, investors may decide better performance is
ahead, and vice versa.
In 2009, an
article in Forbes stated, “Mean reversion is an odd concept because it's
clearly not causal. The market's historic return of 9 percent a year is based
on over 100 years of data (what's typically considered the modern stock
market), and, of course, the ride to 9 percent is a bumpy one with major
double-digit up years and big double-digit down years all averaging to that 9
percent number.” The point is any average is a moving target. After all, a
significant downward movement pushes the historical mean lower and a
significant upward shift pushes it higher.
Regardless of the
investment theories employed by analysts and money managers, investors may want
to set financial goals, carefully choose asset allocation strategies, hold
well-diversified portfolios, and maintain their long-term perspective.
Weekly Focus – Think
About It
“Thousands
of candles can be lighted from a single candle, and the life of the candle will
not be shortened. Happiness never decreases by being shared.”
--Buddha
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