⚡️Market Strategy Flash
September 4, 2026
Ordinary Least Squares (OLS)is a common statistical method used to estimate the unknown parameters in a linear regression model. Its core objective is to calculate a “best fit” straight line through a set of data points by minimizing theSum of the Squared Residuals (SSR)or differences between the observed data and the estimated regression line. In the classroom, textbook OLS regression assumes that error terms are independent, uncorrelated and identically distributed “white noise.”
In real-time financial markets, however, asset prices don’t immediately reset to their “intrinsic” value. Rather, stocks experience multi-year regimes shaped by a host of powerful forces, including price momentum, positioning, investor sentiment, liquidity and regulation. If the S&P 500 trades at a premium to fair value this period (), technical and fundamental tailwinds make it statistically probable for the index to stay at a premium next period (), forming long-term valuation waves or cycles (see the chart below).
A Feature, not a Bug
A couple of weeks ago, I estimated the “fair” value of the S&P 500 using a simple bivariate regression model based on the natural logarithms of: 1)Moody’s seasoned 20-year Baa corporate bond yield; and 2)S&P 500 trailing 12-month operating earnings per share (EPS).
Empirically, we observe persistent, multi-year swings in the error term of my “intrinsic” valuation model, which is a classic sign of auto correlation.Serial correlationoccurs when the error term at time () is strongly correlated with previous error terms (). Rather than looking like a “random walk,” the error term traces smooth, low-frequency waves around its mean of zero because positive (negative) residuals tend to follow positive (negative) residuals (see the chart below).
Equity Valuation Residuals Don’t Scatter; They Wave or Cycle
Sources:FRED, Moody’s, S&P Global, WCG, 08/24/26.Notes:NBER = National Bureau of Economic Research.
From a strict, pure econometric standpoint,autocorrelationviolates classicalGauss-Markovassumptions. While earnings (t-statistic = 32.57) and interest rates (t-statistic = -3.11) remain highly significant and intuitive determinants of share prices, regressions of trending variables – albeit “normalized” – can understate or deflate coefficient standard errors (SE).
From a practical market strategy perspective,persistent oscillation of an error term is a feature, not a bug of a working valuation model. If the residual were “white noise,” the stock market would have no valuation waves or cycles. In other words, serial correlation creates a measurable pattern of valuation risk: Premiums (+2 SE) and discounts (-2 SE) can endure – and even compound – before eventually reverting toward their mean.
False Precision
The historical symmetry and rhythm of the error term in my model is seductive: At a casual glance, it looks like the ultimate “buy low, sell high” cheat code. Specifically, it correctly identified the deep -40% washout following the “Global Financial Crisis” and “Great Recession” of 2008-2009, the epic +60% valuation bubble of the “dot.com” era, as well as the severe -30% discount of the early-1990s recession.
Misinterpreting such “fair” valuation models astactical trading signals(i.e., hard, mechanical triggers to either raise cash positions or short stocks) is where even the more experienced practitioners can get carried out of the game on stretchers. Rather, my model should be used as a gauge of the prospective risk/reward embedded in share prices, not as a short-term timing tool.
The “Irrational Exuberance” Trap
The biggest vulnerability of fundamental “mean-reversion” models is the timeframe mismatch. Arguably, fundamentals shape stock market returns over longer time horizons, whereas technicals influence returns over shorter ones (e.g., intra-day).
- Being Early = Being Wrong:Imagine using a strict “sell” signal of +30%, an overvalued threshold that the S&P 500 crossed in early 1998. If an equity trader shorted or liquidated their portfolio at that time, they would have sat in cash while the stock market rose another 36% over the next two years!
- “Sticky” Residual:Valuation requires a catalyst or a change agent. Extreme premiums (discounts) tend to breed even more extreme premiums (discounts) before the fever finally breaks because the residual is “sticky” or autocorrelated.
Use With Caution
In my humble opinion, it’s appropriate to invest in stocks for the long run, although some operating conditions may be better than others. While my model fails in a day-trading environment, for example, it can be a usefulStrategic Asset Allocation (SAA)tool. Instead of binary buy/sell decisions, institutional allocators use oscillators like this one to dynamically tilt portfolios:
- Scaling Beta (0% Zone):When the oscillator sits near 0% or “fair” value, investors might choose to hold a neutral, benchmark allocation to US large market capitalization equities.
- Harvesting Risk (+30% Zone):When the premium crosses +30%, don’t panic-sell. Instead of committing new capital to US large cap-weighted indices, consider rebalancing by trimming high-velocity winners (e.g., semiconductors) and rotating into lagging segments (e.g., software), equally-weighted or smaller-cap indices, high-quality and low-volatility factors, income, international, etc.
- Deploying Cash (-20% Zone):When the oscillator plunges into the discount zone, it gives disciplined, contrarian investors the quantitative courage to buy when they may not want to. That’s when we tell advisors and their clients to deploy excess cash and overweight US large-cap stocks in globally-diversified portfolios.
Market StrategyFlash,S&P 500: The Tug of War Between Earnings & Interest Rates, August 21, 2026
Definitions
S&P 500: A stock market index tracking the performance of 500 of the largest publicly traded companies in the United States. It serves as a primary benchmark for the overall health of the U.S. stock market.
Operating EPS: A company’s net profit from regular business operations divided by its outstanding shares, excluding one-time gains or losses. It shows how much profit a company generates from its core everyday business.
P/E: A financial metric calculated by dividing a company’s current stock price by its EPS. It shows how much investors are willing to pay for every dollar of the company’s profit.
NBER Recession: A significant decline in economic activity spread across the economy, lasting more than a few months, as officially designated by theNational Bureau of Economic Research. It is determined by analyzing factors like gross domestic product, income and employment.
Moody’s Seasoned -Year Baa Corporate Bond Yield: The average interest rate paid on corporate bonds with a 20-year maturity that are rated Baa, which represents medium-grade investment bonds with moderate credit risk. It serves as a key benchmark for corporate borrowing costs.
Natural Logarithm: A mathematical function that determines the exponent to which the constante(approximately 2.718) must be raised to equal a given number. It is widely used in finance and science to model continuous growth rates.
Standard Error: A statistical metric that measures how much a sample mean is expected to deviate from the true population mean. A lower standard error indicates that the sample data provides a more accurate estimate of the whole population.
R-Square (Coefficient of Determination): A statistical measure that indicates the percentage of variance in a dependent variable that can be explained by an independent variable in a regression model. It ranges from 0 to 1, where higher values show a stronger fit between the data and the model.
Gauss-Markov Theorem: It states that in a linear regression model where the errors have an expected value of zero, are uncorrelated, and have equal variance, theOrdinary Least Squares (OLS) estimator is the Best Linear Unbiased Estimator (BLUE). This means that among all linear, unbiased estimators, the OLS estimator achieves thelowest possible variancefor the regression coefficients.
Disclosures
The views expressed are for informational and educational purposes only and are subject to change without notice.
This material is not intended as, and should not be interpreted as, individualized investment advice or a recommendation to buy, sell, or hold any security, sector, industry, or investment strategy.
References to specific companies, securities, sectors, or industries are for illustrative purposes only and should not be construed as investment recommendations.
Investing involves risk, including the possible loss of principal. Investments in a specific industry or sector may involve greater risk and volatility than more diversified investments.
Past performance is not indicative of future results. No investment strategy can guarantee a profit or protect against loss.
Forward-looking statements, including views about future demand, pricing, supply, or industry cycles, are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results may differ materially.
Data and information are believed to be reliable, but accuracy, completeness, and timeliness are not guaranteed. Source documents should be retained for factual claims, third-party research references, and company-specific data.
Portfolio holdings, allocations, and risk budgets are subject to change based on market conditions, client objectives, and investment guidelines.
The author, firm, clients, or related persons may hold positions in securities mentioned and may buy or sell those securities without notice, subject to applicable policies and regulations.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through WCG Wealth Advisors, LLC, an SEC Registered Investment Advisor. WCG Wealth Advisors, LLC and The Wealth Consulting Group are separate entities from LPL Financial. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results.
All information in this report is believed to be from reliable sources; however, WCG Wealth Advisors, LLC, makes no representation as to its completeness or accuracy.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the companies as well as broad market, economic and political conditions. Stock investing involves risks, including fluctuating prices and loss of principal. Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. (135-LPL) International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. (93-LPL)
The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors. (122-LPL)
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss. (28-LPL)
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. (26-LPL)
Standard deviation is a historical measure of the variability of returns relative to the average annual return. If a portfolio has a high standard deviation, its returns have been volatile. A low standard deviation indicates returns have been less volatile. (131-LPL)
This is for educational / general purposes only, does not constitute investment, tax or legal advice and should not be relied on as such. This is not to be construed as an offer to buy or sell any financial instruments. Any strategies discussed are not intended to be relied upon as the sole factor in making an investment decision for any individual. As with all investments there are associated inherent risks. Please obtain and review all financial material carefully before investing. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly. These comments should not be construed as recommendations but as an illustration of broader themes.
Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations. In addition, forward-looking statements, including index targets or market scenarios, are hypothetical in nature, reflect current views and assumptions and are subject to change based on market and economic conditions and are not guarantees of future performance. This is a hypothetical example and is not representative of any specific investment. Your results may vary. (88-LPL) Scenario outcomes are illustrative and not predictive. This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. Indexes are unmanaged and cannot be invested in directly. (102-LPL)
Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
Publication Date: September 4, 2026
For Public Use in the US
The Wealth Consulting Group
LPL 1169823