Mean Reversion: Statistical Fact or Dangerous Delusion?

Much of investing, especially contrarian, is built on the belief that things revert back to norms, either over time or in the cross section. Thus, when you argue that stocks are over priced at a PE of 25, because the historic average is 16, you are buying into mean reversion, just as you when you argue that a steel company trading at 6 times earnings is cheap, because the sector average is 12. While mean reversion is a powerful force, I argue that there is more nuance than we let on, that structural changes can lay waste to it and converting statistical significant to real money is difficult, using the Shiller PE as an illustrative example. Slides: http://www.stern.nyu.edu/~adamodar/pdfiles/blog/MeanReversion.pdf Post: http://bit.ly/2bJzp6k Market timing spreadsheet: http://www.stern.nyu.edu/~adamodar/pc/blog/mkttimingCAPE.xlsx

Comments

1. Excellent video!! I'm intrigued by the idea of a mean reverting stock trading strategy but even before I watched the video I was skeptical on its usefulness. I think it may be possible to do but I'm sure its not as simple as looking a ratio and trading away based on mean reversion.
   
   Thank you very much for explaining the application of a fairly complicated concept!
2. Good video. I am sure your ending point of 2016 also has an impact. It pushes up the idea that buying when CAPE is higher still generates decent returns. If we crash tomorrow, these findings would be a bit different.
   
   What are your thoughts on using CAPE to find cheapest stocks, sectors, countries?
   
   Have you seen Research Affiliates asset and smart beta projections? I think they are near tools that are quite useful for general purposes.
3. bankers are so stupid and ivy league training doesn't help, that's why markets crash so epically, they are just not intelligent. even trump thinks they are stupid.
4. reality is a composition of total averages calculated by the universe.
5. I think it would be important to mention, as you did in this video, that in 1985 the Dow Jones Industrial Average had a dividend yield of 6%, which was in the emerging markets post-railroad, high-tech world in which we now live. In addition, it was in an era of lower taxation, too.
6. Could you please elaborate more on your sentence "central bankers have contributed to an environment of low economic growth and higher risk premiums."?