I often refer to the tendency for prices, valuations, and other investment metrics to “revert to the mean”. When I do, I’m usually talking about the ratio of house prices to earnings; the cyclically adjusted price/earnings (Cape) ratio of a market; or corporate profit margins in the US.
I’ve been looking at a report on this from Mark Urquhart, one of the indefatigable optimists at Edinburgh based Baillie Gifford (I am on the board of one of its investment trusts). According to him, the four most dangerous words in investment are not, as most of us think: “this time, it’s different.” They are: “reversion to the mean”.
When it comes to individual stocks or sectors, he says, the idea that prices will return to some kind of average assumes that the “external environment remains the same over time”. But, he argues, it doesn’t. Instead, we are living in a period of exceptionally rapid change – change that can have a “profound effects on equities”.