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>> If stocks have been on a recent runup, gaining, say, 50% or 100% over a period of a few years, then they are very likely to grow more slowly than average (i.
by smallgovt 9y ago
>> If stocks have been on a recent runup, gaining, say, 50% or 100% over a period of a few years, then they are very likely to grow more slowly than average (i.e., revert to the mean) over the coming years
This is incorrect. Prior performance of the market over the span of years has little to no predictive power on future performance of the market.
Your statement is like saying: Because I flipped a coin and got heads 10 times in a row, I'm more likely to get tails in the future.
While it's true you should expect the market to revert to the mean over the coming years, there's no evidence that it will grow 'more slowly than average' in the coming years to 'make up' for the hyper growth in past years. If you were a betting man (and a non-sophisticated investor), you should bet that the future years will grow at exactly the historical mean.
Edit: I did some analysis on historical S&P 500 pricing to validate my intuition.
On average, the monthly growth rate of the S&P in a month following a bear month is -0.39%
On average, the monthly growth rate of the S&P in a month following a bull month is 1.08%
You might argue that it takes longer than 1 month for the market correction to occur, so I've included the script and data set I used here for you to play around with: https://pastebin.com/F78pLUka https://pastebin.com/F78pLUka. You can use any cadence, and will find the same relationship.
Empirically, you cannot time the market, which implies future growth rate is not affected by past growth rate.
- sokoloff 9y agoStock prices aren't the outcome of lotto balls or coin flips. In theory, over the long-run, the price of shares will represent an equilibrium of investors' opinions of the intrinsic value of a company (divided by the number of shares). The intrinsic value is commonly modeled as the net present value of future cash flows plus a discounted terminal enterprise value. For the same inputs (sequence of future cash flows, enterprise value, and weighted average cost of capital [discount rate]), the long-run value will be the same. If the near-term share price value rises more quickly than the long-run intrinsic value model, it is entirely reasonable to assume future growth of share price will moderate, as it must in order to converge on the same long-run value. I think it's not at all like your example with 10 coin flips in a row.
- JoeAltmaier 9y agoThere's some truth to the 'random variable' theory. I think we only value stocks the way described (intrinsic value model) because its a cultural myth to do so. We can also think of stock certificates as baseball cards - of value mostly to other collectors. Sure there's a 'book value' or 'dividend value' behind them, but that's irrelevant most of the time for most stocks.
- ohyoutravel 9y agoAbsolutely not true. Days of stock market movement aren't independent events, they're loosely coupled together and with the economy overall. Your comment is a good example of, "Knowing just enough to get into trouble."
- smallgovt 9y agoIt's actually your mentality that gets you in trouble because it leads to individuals trying to time the market when they can't. My assertion is that you cannot time the market at all. As a result, I'd just invest passively and immediately. For data that supports my assertion, please see the edit of my original comment.