One concept that is common in the investment world is the idea that assets will typically revert to the mean or mean reversion (the average). This may seem a bit contrarian since it essentially means that when an asset price returns in excess of its long term average return profile, over time it will likely reverse course and return to that long term average. Imagine a rubber band that gets stretched…. and then eventually snaps back to its normal size.
But that’s not always the case. As famous technician John Roque often says, “we are in a reversion beyond the mean business, and not just to the mean.” The core point here is that markets can (and often do) overshoot to the upside and the downside.
This applies to today’s markets. Many are looking for the correction that should materialize any second, while others are looking for a big drawdown that might be coming as soon as the Quantitative Easing rig is up. But how many are expecting a liquidity based overshoot or a reversion past the mean to occur before this cyclical market is over? True, there are many scary scenarios that could unfold if the wrong things happen. But it’s also true that central bankers seem focused on producing growth in asset inflation to promote a wealth effect in the economy, and are throwing trillions of dollars into the global hopper to make that happen.
There are no guarantees in life except death and taxes, and with the short term complacency, a correction could break at any moment. I’d give as much respect to the possibility of a reversion past the mean to the upside as I would to a market meltdown, given present conditions. It’s dangerous out here, but as Roque said, this is a reversion past the mean business. If this kind of liquidity can’t produce an overshoot, I’m not sure what would.
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