Regression to the mean or momentum?

Investors face a crucial decision-while the US markets may see short-term underperformance, the jury's still out on India

T he dilemma most investors currently face is what to do with the US and India. These two have been the best-performing equity markets in the world over the last 30 years, but they are currently the two most expensive. Should one believe in regression to the mean, and move away from these two equity markets in the belief that valuations always return to the mean? They have outperformed for too long - is it time for other markets to shine? Or should one continue with the momentum? The US and India have delivered the best returns in dollar terms over the last 30 years, and they have done so consistently. Why change what is not broken? What could cause these markets to now underperform, beyond valuations? Valuations, as is well known, are not a timing tool and there seems to be nothing on the horizon to improve the relative prospects of other markets.

This decision to either let your bets ride on the assumption that current momentum will continue, or to switch your assets into relative underperformers is the biggest call any global investor needs to make.

When one looks at the US, its longterm track record is phenomenal. It has not paid to bet against the US. At the beginning of the 20th century, the US accounted for about 15 per cent of world market capitalisation, second only to the UK, which was at 24 per cent. By 1910, the US had crossed the UK to become the largest equity market in the world. It has since retained this title, unchallenged except for a brief period in the late 1980s, when Japan held the top position.