Over the past decade, stock markets have drifted far from their typical behavior in several ways. There is a big opportunity at hand if markets should end up moving back towards normal as they generally have in the past.
This idea is known as “mean reversion” in investing jargon. It sounds complicated, but it’s pretty straightforward: if a measurement has tended to gravitate towards its historical average in the past, then there’s a good chance it will continue to do so in the future. This is especially true if there are sensible “real-world” reasons to expect the mean reverting pattern to occur.
Below we’ll describe a number of measures that have been historically mean reverting for good reason, but that have strayed very far from their typical levels in recent years.
We’ve discussed this one often, but it’s a very important and dramatic example of deviation from historical norms.
The chart below shows stock valuations, aka expensiveness, for US, international developed, and (with a shorter history) emerging stock markets.(1)
A couple things jump out....