“Markets tend to return to the mean over time.” A simple rule by investing legend Bob Farrell, but elegant. Interest rates may move in Nikolai Kondratieff long-term waves, and we may well be in a secular bear market, but there are also short-term cycles within that longer-term trend where profitable opportunities emerge. I sense we are at one of those short-term turning points, at the very least.the end of the tightening phase each and every time.
The same holds true for the equity risk premium, which is fast approaching zero for the first time since 2002 — another period to have been overweight bonds and underweight equities in the asset mix. A Bob Farrell-like mean reversion here would imply, as a base case, the S&P 500 correcting further, to around 3,200 or 3,300, and a coincident adjustment lower in the 10-year Treasury note yield to a band of 2.5 per cent- to three per cent.
I should add that the last time the net speculative short position was anywhere close to being this extreme was back in September 2018 and over the following 12 months, the detested 10-year Treasury note yield plunged from three per cent to 1.8 per cent, and that in turn generated a very nice 14 per cent total return 12 months hence.
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