What is reversion to the mean in regards to stocks or the entire stock market as a whole?
On any single day the stock market is a casino. Traders bid stocks up or down based on facts and feelings. If a stock is bid up really high, any event can cause sense to bid it back down. If a stock is bid up really low, any event can cause sense to bid it back up. A stock is a fractional ownership of a real business. A business produces and sells products. The value of that stock represents the underlying value of that business.
Reversion to the mean simply states that while there may be wild swings on a day to day basis, and bubbles at that, over time the returns of a stock or the market as a whole should annually be the output of that market. So if one was to purchase VTSAX, which is the entire US stock market as a whole, one may expect, based on historical results for what they are worth, a return between 7-10% annualized over time.
For example, should there be a really strong decade of 15-20% annualized returns, one should expect the following decade to possibly have returns close to 0% annualized in a reversion to a mean over 2 decades. And for that matter, a decade with close to no returns should be proceeded by a decade of tremendous returns. This period of time is not set in stone. It can be a 2-3 year span, or 10 or more years span. The bottom line is if industry is expanding, innovating, and producing and selling, it should present back in the price of it as a whole at some point.
On any single day the stock market is a casino. Traders bid stocks up or down based on facts and feelings. If a stock is bid up really high, any event can cause sense to bid it back down. If a stock is bid up really low, any event can cause sense to bid it back up. A stock is a fractional ownership of a real business. A business produces and sells products. The value of that stock represents the underlying value of that business.
Reversion to the mean simply states that while there may be wild swings on a day to day basis, and bubbles at that, over time the returns of a stock or the market as a whole should annually be the output of that market. So if one was to purchase VTSAX, which is the entire US stock market as a whole, one may expect, based on historical results for what they are worth, a return between 7-10% annualized over time.
For example, should there be a really strong decade of 15-20% annualized returns, one should expect the following decade to possibly have returns close to 0% annualized in a reversion to a mean over 2 decades. And for that matter, a decade with close to no returns should be proceeded by a decade of tremendous returns. This period of time is not set in stone. It can be a 2-3 year span, or 10 or more years span. The bottom line is if industry is expanding, innovating, and producing and selling, it should present back in the price of it as a whole at some point.
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