This is why trees don’t grow to the skyOct 10, 2019
Mean reversion is one of the most important concepts in finance and investing.
Prices which stray too far from the long-run norm are likely to revert to the mean, or long-run average.
Over the short term, price and value can become decoupled, but over the long run they will always be linked.
What this means is that periods of strong returns in markets are almost invariably followed by periods of weaker returns.
How can you do better than average, given that this is the case?
One answer is, simply, by buying into markets that have underperformed recently, rather than following the momentum of markets which have been the strongest recent performers.
Humans are a strange bunch, though, and they tend to do the opposite, instead preferring to believe or hope that trees can grow to the sky.
I discussed this a little further in the short video here
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