Although painful, this correction has led many asset classes to offer reasonable—and in several cases, impressive—forward-looking premiums for bearing risk. This situation was not the case in the past few years; investors evidently felt entitled to higher and higher returns for bearing less and less volatility. Many of our friends and clients have heard us remark in recent years about the dearth of "low-hanging fruit"-that is, markets that are attractively priced relative both to other markets and their own history. Today, low-hanging fruit abound. Indeed, almost too many markets are attractively priced!

Risk premiums have a habit of nearly always drifting back to an equilibrium—which is what we mean by "mean reversion." The reversals may, however, cause prices to snap back "too much" relative to a "reasonable" level. Too small a forward-looking risk premium quickly becomes too large a premium. Today, we are actually witnessing in some categories forward-looking risk premiums well above historical norms for the first time in many years. This situation is good for those who will be net purchasers of assets. It doesn't do much to ease the recent pain, but it reminds investors that it is always darkest and coldest right before dawn. We think the next few months will afford buyers some of the best opportunities in years to embrace risks that others shun and wade far afield in our search for attractive asset allocation opportunities.

Mean Reversion In Equities

The phrase "What goes up must come down" applies equally well to Newton's apple and the stock market. No individual stock—or, for that matter, asset class—will outperform peers forever. Inevitably, prices adjust. We illustrate this powerful trend with an examination of the top 10 U.S. stocks by capitalization through time. And we explore how investors can benefit from mean reversion in the current markets.

Of course, there are two ways a stock can make it on to this exclusive top 10 list—it is a large company whose future results will validate its lofty ranking or it is overvalued, perhaps dramatically so. These overvalued shares presumably have recently experienced dramatic run-ups in price to make it into the top 10. This is where mean reversion comes into play. The market will realize expectations for these stocks have gotten ahead of themselves and they will revert to some price level that more accurately reflects future prospects.

The performance implications of mean reversion for capitalization-weighted indexes are huge because the top 10 companies have the largest weights in the index. Thus, their subsequent underperformance will bring the whole index down. This outcome is easily seen in Table 2, where, on average, only 3 of the top 10 stocks by capitalization outperformed over the subsequent 10 years and, cumulatively, all 10 underperform the average stock by almost 30%.

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