I’ve posted Entry #653 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called It’s a Confounding Reality That Stock Prices Revert to the Mean.
Juicy Excerpt: The widespread belief that stock prices revert to the mean is not intuitive. Most people believe that the market sets stock prices through a rational process, that all of the economic developments of the day are taken into consideration by millions of investors and that prices are recalibrated and set in their new proper place. If that were the reality, the mean stock price (a CAPE value of 17) would have no significance. Each day of stock pricing would be independent of all the others. What happened at earlier times would tell us nothing about what the stock price should be today.
But it clearly does. Bogle was the king of Buy-and-Hold. He was disdainful of market timing (in fairness, he softened his view a bit in some comments that he made as part of a long-running debate on safe withdrawal rates that I started way back in 2002). The objection to market timing is that no investor can know better than the market where prices should be. But that is clearly not so if reversion to the mean applies. All that the investor needs to do is to take note of how far from the mean the current price is. He can safely predict the direction in which prices will be headed in the long term and the strength of the pull that will be felt in that direction.
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