The Reversion Version

Last week there was 32. This week there are 14. Next week there will only be 8 left.

No, that’s not the number of your New Year’s resolutions still unbroken, but NFL teams left this season. We have now reached the knock-out stage of the season, the playoffs, which will climax on Sunday 11th February with two teams facing off against each other in Super Bowl LVIII. This will be the first time the Super Bowl is held in Las Vegas and it is expected that about 180 million people around the world will be watching live.

There is a lot to love about American football, the razzamatazz, the explosive plays, the exciting finales, the crazy weather conditions, and the ample opportunities for snacks during games! But one of my favourite features of the sport is the concept of ‘parity’. The NFL takes a number of steps to create a level playing field across the league, such as imposing a salary cap to prevent wealthier teams from simply outspending others. Although Manchester United and Chelsea are doing their best to show that it doesn’t matter how much you spend, you can stay average for years. (Sorry, I couldn’t resist!)

The NFL also shares revenue equally among all 32 teams, which includes income from television deals, merchandise sales, and other sources. It doesn’t matter how many Taylor Swift fans buy a number ‘87’ Kansas City Chiefs shirt, the whole league benefits. Finally, the college draft system rewards the teams with the worst records with the first picks in each round, providing struggling teams an opportunity to improve by selecting top college talent.

An equivalent concept in investing is ‘mean reversion’. This is the theory that over time asset prices and markets should return towards their historic average. The phrase in the previous sentence doing all the heavy lifting is ‘over time’. How long will things take to rebalance?

US vs rest of world

After a year of strong returns for US equities, especially technology stocks, the US stock market is now looking very expensive against most other markets. For example, the Chinese market currently trades at nearly 55% discount to the US market.

Back in 2016, the UK market was trading at parity with the US market. Since then there has been a steady trend of diverging fortunes, and UK market is now trading at a 45% discount to the US. If your strategy was to buy UK shares in the belief that markets would revert towards historic averages then you would now be entering your 8th year of losing money.

There are a number of reasons for this divergence, including the lack of technology companies in the UK market, foreign investment depleting since Brexit and the poor performance of the UK economy since the pandemic. Can this trend continue? Of course. Will it? Not forever, and the gap is looking stretched, but there will need to be some kind of catalyst. Both countries have elections this year and a lot can change, so we will continue to monitor the situation. In investing, just like comedy, timing is important. And being right, but very, very early is the same as being wrong.

Inflation

The period from 1981 through to 2021 was generally one of declining interest rates and low inflation. This changed in 2022, when the central banks were forced to begin raising interest rates to combat inflation, but with energy prices dropping in recent months and inflation coming back down, there has been some speculation that rates may be returning to ‘normal’. This is understandable, as since 2008 people had become very used to low interest rates and reducing inflation (disinflation) and have positioned their portfolios accordingly. But averages are a funny thing. You can have your head in an oven and your feet in ice, but on average you feel fine.

The question we must ask ourselves is, will rates revert to the average of recent years, which is much lower than the long term average, or are we now entering a period of higher interest rates and higher inflation? In a word, probably the latter! It seems unlikely central banks can return to such easy money conditions, other than temporarily in response to recessions. The pandemic lit a firework under global supply chain issues, the recent cost of living crisis has shone a light on workers’ salaries, and the higher level of debt across the developed world is tying the hands of central banks.

In the same regard, if you were an investor in the early 1980’s you would have been forgiven for thinking that inflation rates would revert to the high levels seen throughout the 1970’s, and most likely not anticipate the effect of globalization would last for the next 30 years. We are now on the other side of this trend.

For these reasons we have increased our exposure to commodities and have no long term bonds.

It’s Showtime

If you decide to stay up and watch the Super Bowl this year, and at 1am when you are watching Usher strut his stuff in the half-time show, consider this…

The goal of parity in the NFL is to maintain a competitive balance among teams, year after year, which in turn fosters excitement and unpredictability. This ultimately contributes to the league’s enduring popularity, but it also translates to commercial success. The TV rights are hugely lucrative and advertisers are willing to pay up. During the first Super Bowl in 1967 it cost $42,500 for a 30 second advert, by 2000 the cost had risen to $2million. Last year the cost was $7 million.