On Playing the Odds to Improve Your Batting AverageApril 17, 2015
As baseball season commences we thought it only appropriate to draw an analogy between America’s favorite pass-time and investing. As every good baseball fan knows, batters in baseball acquire a batting average that is aggregation of a players cumulative hits divided by the total at-bats throughout a season. Throughout the season a batter might go on runs or slumps in which their batting average is materially higher or lower than their season long batting average. But, at at the end of the day, all those cyclical ups and downs eventually revert to a somewhat predictable mean.
The same concept goes for investing: sometimes stocks in a particular market are hot (outperforming), and sometimes they are not (underperforming), but they always return to the mean in due time.
So with that, here is a review of the cyclical batting average of a few widely followed markets around the world. Each chart below shows the percent of stocks in that market that are outperforming the global stock market over the previous 65 trading days. The point here is to recognize where stocks in a particular market are in their cyclical outperformance/underperformance trend. Since all of these series predictably display strong return the mean characteristics, when too many stocks in a market are hot one should consider reducing exposure, and when too many stocks in a market are not, one should consider adding exposure.
Right now Europe and Asia are smoldering hot, and North America is cold to lukewarm. EMs are are heating up, but not yet boiling. Thus, if one wants to play the odds, one would think seriously about tactically reducing exposure to developed Europe and Asia in favor of North America.