Does anything revert to mean any more?
One thing that bears nearly all have in common is a faith in mean-reversion. Edward Chancellor at Breaking Views today asks whether such faith is really justified, especially when it comes to the all-important US housing market. He notes a couple of datapoints which would seem to indicate that it isn’t: the US stock market corrected from its highs but never reverted all the way back to its mean, and the UK housing market barely corrected at all, after rising more than three standard deviations away from average, and is now on its way back up again.
Maybe, Chancellor concludes, mean reversion is something which only happens when interest rates are rising, or there’s severe deflation. Or maybe it’s just something which takes a very long time:
Grantham’s faith in mean reversion is unshaken. The process just takes longer than most expect. “I seem,” he says, “to spend most of my life waiting for something to happen and just a small amount of time watching it happen.” The exponents of mean reversion are distinguished not by complex analysis but by extreme patience. That’s a quality of which the investment community is generally short.
Of course, investment professionals generally can’t afford to be patient: making the right call too early is often worse than making the wrong call entirely.
No Responses to “Does anything revert to mean any more?”
Simply because one believes in reversion to the mean does not imply that one believes the mean is static.
Mean reversion in equities uses an inflated P against an inflated E, so the P/E ratio can revert, even with inflation.
In housing prices, there is no denominator. Is Mr. Chancellor using inflation-adjusted prices – and if so, what is he using? (There are some that believe that federal statistics under-report actual inflation.)Hence the validity to the comment that the mean may not be static.