Principles don’t change, that’s why they’re called Principles

If investors agree that prices of assets seldom move uninterrupted in the one direction, then they should agree that the same prices also revert to their mean at some point. Lately, I get a feeling that investors don’t agree with the latter.

Mean reversion is a mathematical premise that is healthy for the behaviour of assets price, however it is important to understand that asset prices can also overshoot their mean, as markets aren’t always efficient in their discovery of price. Therein lies opportunity.

Opportunity (rather than concern) also lies in the volatility exhibited in an asset’s price. Volatility is often and incorrectly confused with risk.

Whether or not it works in sync with a mean regression theory, volatility is the price you pay for long-term gains in financial markets.

Paraphrasing investor, Sir John Templeton, “the normal range of volatility for stock prices is proportionate to the square root of its price”.

However, I have never seen an industry that is cyclical magically become non-cyclical and nor vice-versa.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: