You Are Being RedirectedThis blog has been moved to http://resourceadvisor.com/blog/. You will be redirected in a moment. If you are not redirected in 10 seconds, click here.

0 Nov 3 2011 @ 10:55am by Matt Smith in Global Energy, Risk Strategy

Revertigo

In the TV show ‘How I Met Your Mother’, there is an episode which deals with the condition ‘Revertigo’. This occurs when you are reminded of something from the past, and it triggers you to act like you did at that time. As humorous as it sounds, it is no laughing matter. And it exists as much in commodityland™ as it does in TV shows. So here are a few observations about revertigo in action, through some pics, quotes and quips.   

Let’s start with theory, and an old favorite of mine: Bob Farrell’s ten rules of investing. Rule numero uno is: ‘markets tend to return to the mean over time’. Investor judgment is especially clouded at extremes, be it by euphoria at one end of the spectrum, or pessimism at the other. But regardless of these moods and subsequent moves, Bob assures us that markets tend to revert to the mean over time.  

But what does reverting to the mean, err, mean? Mean reversion is a theory which states that even if  prices may throw some crazy moves in the near-term, they will eventually move back to an historical average or a mean. A great example of this in commodityland™ is the price of WTI crude oil. Despite its vacillations, prices tend to gravitate back to the mean reversion of the  200-day moving average (black line):   

  

Mark Twain summed up this move back to equilibrium when he said ‘history doesn’t repeat itself, but it does rhyme’. Although he was talking in broader terms, this expression is as applicable to financial markets as it is to anything else. History repeating itself – or patterns – represents one of the cornerstones of technical analysis, as patterns can be used to predict future market movements. Ergo, markets get revertigo. That’s why technical analysis is great, and both Summit’s technical guru Brian Swan and Mark Twain are legend…wait for it….dary.  

Despite the naysayers who debunk mean reversion as a thing of the past, there are plenty who are willing to defend the cause. An avid advocate is investment and behavioral finance guru James Montier, who defends his stoic stance on the subject by sayingduring pretty much every “new era,” someone proclaims that the old rules simply don’t apply anymore’.  But yet we always revert to revertigo.   

Timing is everything.

But herein lies the problem. Despite the knowledge that markets will get revertigo, the hard bit is knowing when. As the lady in the picture to the left will tell you, timing is everything. So I leave you with this final quip. We have previously discussed on the burrito how markets are not always wholly efficient nor rational (through Scooby Doo). Even the best minds in history, such as John Maynard Keynes (great economist, terrible investor) experience this futility. As he most famously quipped, waiting for revertigo can be like waiting for Godot: ‘markets can remain irrational a lot longer than you and I can remain solvent’.

Leave a comment:

» will not be published