Wednesday, December 27, 2017

Mean reversion is not the same as contrary thinking. A big confusion for many managers


".... equities have to go down because the market has risen too fast" 

"The business cycle has to turn down since the recovery has lasted so long....."


"The bad performance of value investing will improve next year...."


"Financial condition have been very good which means that it will likely get worse in the future"


"What goes up must come down, and what goes down must come up!"



Disagreeing with the consensus or trend is not always contrary thinking or mean-reversion thinking. It is sometimes being different for the sake of being different. 

Too much of mean-reversion commentary especially at the end of the year is based on the idea that being different is insightful but it is often without the insight. By being contrary to the current market, the analyst can be considered prescient. Herb Stein may have stated that, "Things that cannot go on forever, won't", but that is not a forecast.

I take a different view that is grounded in the fundamentals of trend and momentum. Trending markets are likely to continue to trend. I always remember the adage from my old mentor John Henry, "Trends will last longer than expected." There will a reason for reversal, but without a strong narrative based on fundamentals, it is best to stick with the trend. Markets will get extended, but trying to find the top is difficult. Being cautious or risk averse is fine, but that is not the same as being contrary or basing a view on mean-reversion. 

So for the new year, read the forecast, take in the views, but remember that just stating that markets will mean-revert is not the basis for a good forecast. 

See,

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