Inside Markets — Mean Reversion
Mean Reversion
January 14, 2025
The recent choppy pullback in US equity markets reflects expectations for fewer Fed rate cuts in ’25 and higher bond yields amid an uncertain policy transition. The distribution of potential outcomes is widening as participants debate the sequence of Trump 2.0 policies, which is leading to portfolio risk reduction. In our opinion, this uncertainty discount will unwind soon after the inauguration, but will likely return as investors jump from one headline to another. This suggests a period of elevated implied equity volatility, which means higher risk premia/lower multiple – for now. We’re still in a bull market and expect the overall trend is still higher but the degree of difficulty is also higher.
The S&P 500 (SPX) is ~4% off its all-time high from December 6 and nearly oversold after filling the post-election upside gap at ~5783. The index broke below its 100-day moving average (~5825) yesterday before reversing higher to avoid CTA momentum selling. Yesterday’s reversal also triggered bullish momentum divergence signals that implies a period of mean reversion. If we’re wrong, a break below the 100-day moving average opens the door to next level support at 5626, which implies another ~4% downside from current levels. That type of outcome would align with our potential 10-year yield test at 5%. As we noted yesterday, we’d first view that kind of test as a major buying opportunity for both bonds and stocks.
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