Why Does This Crazy Stock Market Keep Ignoring Jack Bogle’s ‘Iron Rule’?

Vanguard founder Jack Bogle once said that ‘reversion to the mean’ is the stock market’s iron rule. (Taylor Hill / FilmMagic / Getty Images)

Now that Nvidia earnings (and summer) have come and gone, we can turn our attention back to the never-say-die market, writ large.

Truly, this bull market is like the infamous Russian mystic Rasputin—it just can’t be killed off. Stubbornly high interest rates, a bewildering series of tariffs, slowing job growth, and housing market weakness —what’s a squishy macro environment got to do to get some attention around here?

Sure, the rose-colored glasses crowd can argue that unemployment remains low at 4.2%, wage growth is strong at 4.1%, and gross-domestic-product growth was solid at 3.0% in the second quarter. Net-net though, there’s a stronger case that the market’s shrugging off warning signs rather than basking in the glow of an America is Great Againaissance. After all, President Donald Trump’s badgering of Federal Reserve Chair Jerome Powell to cut interest rates suggests that POTUS himself thinks the economy needs some goosing.

Not that Mr. Market needs any help flexing, with the S&P 500 index up 10.2% this year, following gains of 23.31% last year and 24.23% in 2023. That plus the S&P’s price-to-book ratio of 5.34, (exceeding the 5.05 of 1999, just prior to the dot-com crash), coupled with a trailing price/earnings ratio of nearly 30, suggests that investors are operating in ignorance-is-bliss mode. Which raises the question: Why does this market keep going up?

There are the usual suspects: accommodating Fed policy, the artificial-intelligence revolution, and the Trump TACO trade. But another theory has been making the rounds lately—the Death of Reversion to the Mean.

That stock prices revert to a mean—articulated by Eugene Fama and Ken French, among others—has long been an accepted premise of investing. “Reversion to the mean,” said Vanguard founder Jack Bogle, “is the iron rule of financial markets.” But what if it weren’t true anymore, or at least not as true?

There are at least a couple variations of the end of mean reversion, one put forth by Adam Seessel of Gravity Capital Management, author of Where the Money Is: Value Investing in the Digital Age. Seessel wrote up his theory six years ago in Barron’s, and it has aged well.

When Seessel started his career as an analyst at Sanford Bernstein, he was schooled that stocks immutably reverted to the mean. “But are Kohl’s, Target, and other bricks-and-mortar retailers going to come back?” Seessel asks. “And on the flip side, is Amazon.com going to revert to the mean on the downside? E-commerce has 15% to 20% of retail sales in the U.S. Is that number going down?”

Seessel says that in 2004, 19% of the market’s value was tech; in 2024, it was 46% and is unlikely to decrease, as tech giants like Microsoft and Amazon are growing multiple times faster than the economy.

“Emerson said, ‘A foolish consistency is the hobgoblin of small minds,’ ” Seessel notes, plumbing the great transcendentalist. “It’s good to be consistent, but when the world changes, not so much.”

A more radical end-of-mean-reversion theory comes from Michael Green of Simplify Asset Management. Green argues that passive investing—which now accounts for $17.59 trillion, or 53.4%, of all mutual funds and exchange-traded funds, according to Morningstar—tends to make the market continually rise.

Green, called the Cassandra of passive investing, argues that investors in passive funds are more likely to hold during downturns and choose to reinvest in their funds, resulting in passive fund managers consistently pouring money into stocks. Given that the S&P 500—the index of choice—is market-cap weighted, more and more money flows into Nvidia and the other members of the Magnificent Seven. Green says this “mean expansion” is the reason the market keeps going up, or at least not down.

The rise of passive investing has been studied by the likes of Felix von Moltke of Oxford and Torsten Sløk, Apollo Global Management’s chief economist, who together wrote that “passive investors…have contributed to reduced price elasticity and market responsiveness, which, in turn, have led to amplified price movements, decreased liquidity, potential macroeconomic inefficiencies, and a disproportionate concentration of market influence in a few dominant stocks.”

“Once Vanguard has bought Tesla , do they respond to an earnings report in Tesla? No,” says Green. “That shrinks the effective float in Tesla and raises the volatility of the move in response to an earnings miss.”

Green believes that mean expansion grossly overinflates equity valuations, which worries him. “I’ve modeled this stuff out, and unfortunately, all of these models say you end up with a horrific crash,” he says.

It’s worth noting that Bogle told me in 2017, “If everybody indexed, the only word you could use is chaos, catastrophe….The markets would fail.” He also added, “What are the chances of everybody indexing? It’s zero.” Still, not exactly comforting.

Which brings us back to Rasputin. In 1914, he was stabbed but survived. Two years later, he was fed cakes poisoned with cyanide but survived, then given Madeira wine poisoned with cyanide but survived, then shot but survived, and finally shot again and thrown into a river. At that point, he died.

Eventually this bull market, too, will expire—and revert to the mean.

Write to Andy Serwer at andy.serwer@barrons.com. Follow him on X and subscribe to his At Barron’s podcast.