S&P 500 Exponential Analysis

Guidelines for assessing market levels

Ever since the end of the Great Depression, the market has grown exponentially.

Now, that sentence isn’t an exaggeration, as taking the natural log of the S&P 500 produces a linear result. I’ll stop there since this isn’t a boring math post - all I’m really saying is that there has been an incredible growth rate over the last eighty years.

Since the market has grown exponentially, we can fit exponential equations to the historical data:

Here, we have three different exponential curves which were calibrated using historical sampling and benchmarked against Monte Carlo simulations. Ultimately though, they are just guesses with some extra due diligence. More simply, I made them up but have some bit of defendable analysis to support them.

The reason I like them is that they show three different states of growth for the market: high, medium, and low. They offer a visual guide for us to consider whether the market’s growth is above or below historical trend. If it’s above it may come down and if it’s below it may go up.

This offers some guidance if we are considering investing or selling our investments. It also helps us assess behavior like the current drawdown, so we can better understand whether or not the selling is justified or gone too far. Right now, we are getting close to long-term exponential trend levels, so maybe that suggests the correction from relatively high levels is coming to an end. And, if it goes down further, we have a lower floor to watch for.

All that being said, perhaps the most important use of these exponential trends is to provide a glimpse into the future:

While today’s market actions are painful, even in the more conservative exponential model we have a path for growth. We can also see plentiful upside.

The market will continue to climb higher in the coming decades, so it’s important to recognize that investments today will be worth more in the future. It’s just a matter of how long we will have to wait for that to happen.

After all, we are on an eighty year trend since the Great Depression and if that trend breaks we will probably have much bigger problems to worry about than how much our stocks are worth.