Reversal Or Recovery?

When we think about reversals in the market, we likely think of brief turnarounds in performance. But what if it’s more? What makes a reversal turn into a recovery is a full-fledged long-term improvement in performance.

We can apply this logic to Equal Weight’s recent experience. After consistent underperformance since April 2017, the S&P 500® Equal Weight Index experienced a reversal in the past two months, outperforming the S&P 500 by 2% in October and by 3% in November. As Exhibit 1 shows, Equal Weight reduced its 12-month underperformance versus the S&P 500 by half to 6.2%, compared to August, when underperformance had dipped to 13.5%.

This reversal was primarily driven by strength in smaller caps, as Equal Weight has a small-cap bias. Another tailwind was the recent underperformance of the Technology sector since Equal-Weight has a significant underweight to Tech, which was flat over the past three months, compared to a gain of 4% for the S&P 500.

To provide historical context, we do know that Equal-Weight outperforms over the long-term, and that there is a general trend of mean-reversion from observing the peaks and troughs in Exhibit 1.Equal Weight’s trailing 12-month relative performance versus the S&P 500 has a mean value of 1.2% and a standard deviation of 7.6%. Of course, on its own, this doesn’t tell us whether Equal Weight’s recent performance is a temporary blip or the start of a new cycle of outperformance. To understand this long-term outperformance and the mean-reversion effect, we ranked the months in our database by the 12-month relative performance of Equal Weight and divided them into deciles. Then, we analyzed the median subsequent 5-year annualized performance in each of these deciles.

The results in Exhibit 2 show that we indeed see a reversion to the mean over the long-term: Lower decile months tend to outperform in the future, while higher deciles tend to underperform. Decile 1, or the worst performing decile for Equal Weight, had the best subsequent median 5-year performance, outperforming by 8%.

1 2
View single page >> |

Disclaimer: Copyright © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. This material is reproduced with the prior written consent of S&P DJI. Please ...

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.


Leave a comment to automatically be entered into our contest to win a free Echo Show.