This Won’t Interest the Average Investor

The S&P 500 keeps going up…

As I mentioned a few days ago, we’re fast approaching the second longest economic expansion since the mid-1800’s. But that doesn’t mean it’s time to run for the hills.

Forget the doom and gloom. Yes, the market is due for a correction over the next year or two. Whether that’s 10%, 20% or 30%, no one knows.

That’s fine. You already know the importance of asset allocation to protect your portfolio from big losses.

What’s also important is knowing how to make money in any market. There’s a simple formula for doing it.

The formula… Sell what’s expensive and buy what’s cheap.

It’s not that exciting. It’s so simple it’s boring.

Today, everyone knows the S&P 500 is getting expensive. But the crowd continues to buy it.

One of the core investing principles at The Champion Investor is to never follow the crowd. That means it’s time to look for stock markets that are cheap.

Here’s one way we can do it…

Academic research shows significant evidence of mean reversion in relative stock index prices. Meaning a single country’s stock market compared to the World should fully reverse itself over time.

I did a stock screen to find single country ETFs that have declined the most over the past five years. (There are some newer single country ETFs that have come out that are cheap too. But they don’t have a five-year price history.)

The reason I use five years is because it ties in with research showing evidence of slower mean reversion. In other words, mean reversion takes time.

You also avoid catching a falling knife. Academic research shows downside momentum effects over a six-month to one year period. Which implies more bad results in the upcoming six-month to one year period.

This screen takes out those effects. It produced four countries… Egypt, Greece, Malaysia and Turkey.

The chart below compares those four markets with the S&P 500 and the World market index. (The S&P 500 ETF (SPY), the MSCI World ETF (URTH), the Egypt Index ETF (EGPT), the MSCI Greece ETF (GREK), the MSCI Malaysia ETF (EWM) and the MSCI Turkey ETF (TUR).)

As you can see, Egypt, Greece, Malaysia and Turkey have been beat down over the past five years. Compared to the S&P 500 and the World market.

As I explained earlier, mean reversion suggests that a single country’s market compared to the World index should fully reverse itself over time. Which means that Egypt, Greece, Malaysia and Turkey should go up and the S&P 500 should go down relative to the World index.

This won’t interest the average investor. They’re interested in a stock that “could” go up 487% in two months.

That mindset is like playing roulette. For every one of those there are 1,000 others that go bankrupt.

Great investors take the long view. They know how to make mean reversion their friend.

It’s a simple and profitable strategy that most investors don’t have the patience for. If you’re interested in long-term investment success, use the power of mean reversion.

It’s not exciting. But it’s an investment strategy that works.