Team USA is once again dominating the 2016 Summer Olympic Games.

At press time, the total medal count was 70, including 26 gold medals after the 10th day of the 16-day competition. With a big lead over China, which has a total of 46 medals, including 15 gold, Team USA is on pace to extend its Summer Olympic dominance going back to its modern inception in 1896 according to Wikipedia.

Seeing the Red, White & Blue so often on the podium reminds us of the U.S. equity performance recently. The chart below shows the trailing five-year asset-class performance [1] for each year-end going back to 2006:

The trailing five-year performance of U.S. large- and small-cap equities has been the best of the broad asset classes that we track for the last three years. This recent performance is a real turnaround since the relatively poor trailing five-year performance during 2006 to 2011. 

However, we do not expect U.S.-equity dominance to continue intuitively because the concept of "reversion to the mean" is such a strong and inexorable force in investing. Asset-class outperformance does not last forever; there will be periods of underperformance. The green line in the chart below shows the relative performance between the Russell 3000 Index (a proxy for large- and small-cap stocks in the U.S.) and MSCI World ex USA Index (a proxy for foreign developed large- and small-cap stocks outside the U.S.) going back to 1978:

   

When the green line is moving up, U.S. equities are performing better than non-U.S. equities, and vice versa. It is interesting to note that every time the green line goes above the upper yellow line, which represents one standard deviation relative to the trend, U.S. equities inevitably start to underperform vs. non-U.S. equities, i.e. the green line moves down for a long time.

Today, the relative outperformance of U.S. equities vs. foreign-developed equities is at an extreme — the green line is over the upper red line, which represents two standard deviations above the trend and a rare occurrence not seen since 1978. Again, our expectation is that U.S. equities could start to underperform both foreign equities and other asset classes outside of equities in the future.

The catalyst that may cause the reversion back to the mean for U.S. equities could be the end of the current business-cycle expansion. Out of the 14 U.S. business cycles since 1929, only two lasted longer than the current cycle after the aggregate business profits-to-Gross Domestic Product, (GDP), ratio (represented by the green line below) peaked (designated by the red dashes). And they only lasted longer by 1 to 2 years:

In other words, that we are likely late cycle should not be a particularly controversial topic at this point, in our view. The probability of this business cycle extending past 2017 is low. As a result, the probability of the U.S. equity asset class continuing to dominate is low as well.

However we feel the probability of Team USA continuing its dominance in future Summer Olympics is high!

 

 

[1] Diversified Balanced Portfolio is as follows: 26.5% Russell 3000 Index, 19% MSCI World ex USA Index, 6.5% MSCI EM Index, 12.5% HFRI Fund of Funds Index, 8% S&P Global Infrastructure Index, 6% FTSE EPRA/NAREIT Developed Index, & 21.5% Barclays Global Aggregate Index. Diversified Portfolio assumes daily rebalancing. All data represent total return for stated period. Past performance is not indicative of future returns. “QTR” and “YTD” Data are as of 12/31/15. “10YR AVG” returns represent period of 01/01/06-12/31/15 showing annualized returns over the period. Please see disclosure page at end for index definitions.

 

This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product.  The opinions expressed do not necessarily reflect those of author and are subject to change without notice. Past performance is not indicative of future results. Standard Deviation is a statistical measurement of dispersion about an average, depicts how widely returns vary over a certain period of time. Investors use the standard deviation of historical performance to try to predict the range of returns that are most likely. When there is a high standard deviation, the predicted range of performance is wide, implying greater volatility. Diversification cannot assure profit or guarantee against loss. There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses. Reference to an index does not imply that a portfolio will achieve return, volatility, or other results similar to an index. Performance of an index is not illustrative of any account, portfolio or strategy managed by Sequoia Financial Group. It is not possible to invest directly in an index. Sequoia Financial Advisors, LLC makes no representations or warranties with respect to the accuracy, reliability, or utility of information obtained from third-parties. Certain assumptions may have been made by these sources in compiling such information, and changes to assumptions may have material impact on the information presented in these material