The most overlooked aspect of any investment framework are preconceived notions, otherwise known as absolute truths, that we perceive as eternal, unwavering and unquestionable. It is very difficult to question almost every belief you understand to be true, but it can be extremely beneficial. The more investment experience you have, the sooner you realize that you are not infallible when it comes to investing. As a matter of fact, no one is infallible, which is why we state that you should listen to all, but follow none. The more you question everything, including yourself, the better your odds of success.

Mean Reversions Skew Our Timing

We find that the mean reversion argument overlooks the most important aspect in investing – timing. As a result, if your investment pillar is mean reversion, that is not a good reason by itself. For example, those who claim profit margins mean revert even though they are cyclical have been wrong for a while. That’s not to say mean reversions don’t occur; of course, they do. However, reality is a bit more complicated. Saying a metric is cyclical means it goes up and down with the economy, but that in itself does not prove that everything has to mean revert. Claiming a metric mean reverts is very rigid because it rules out even the possibility of the metric staying where it is for longer than expected because of fundamental reasons. The only way the mean changes is if the metric has significantly diverged from the average for a prolonged period of time that the average moves. If you’re looking at data which covers decades, be prepared to be wrong for years if you think a metric mean reverts when it doesn’t. Therefore, make sure your your investment pillars (thesis) are founded on fundamentals, rather than the belief that something has to mean revert.

Are Commodities Poised To Rally?

The chart below is an example of a one metric some claim will mean revert. It compares the Goldman Sachs Commodity Index with the S&P 500.