When MarketFox columnist Daniel Grioli spoke to GMO founder Jeremy Grantham earlier this year for the [i3] Podcast, he asked whether this time really was different, playing on the famous phrase by investment pioneer Sir John Templeton that ‘this time is different’ are the four most costly words in the English language.
But Grantham answered this with a counter question: “What isn’t different today?”
One of the things that seem to be different today is the role of mean-reversion in investing, Grantham said. The growth-driven environment of today is restraining market forces to bring asset prices back to their fundamental values.
As Head of the Dynamic Allocation Strategies Team at William Blair and a fundamental investor, the death of mean-reversion would have a dramatic impact on Brian Singer’s way of investing.
“What is interesting about the world we live in today is that when the global financial crisis hit, central banks stepped in. Not just one central bank, but a significant portion of the world’s economy has manipulation of interest rates and manipulation of interest rates is the same thing as manipulation of asset prices,” Singer says in conversation with Grioli for the [i3] Podcast.
“When central banks are that powerful of a player, it is very difficult for fundamentals to exert themselves sufficiently to bring prices back to fundamental values.”
He doesn’t believe mean-reversion is dead and expects that over the long term it will remain an important driver, but in recent years it has not been working as it should.
“It is my belief that what has made it so difficult for fundamental investors is that the process has been short-circuited and it will be short-circuited until central banks begin to pull back from these ultra-easy monetary policies,” he says.
Reversion to Fundamental Values
Singer is careful to make a distinction between the concept of a reversion to fundamental values and that of a reversion to some historical mean. Adherence to the latter could spell trouble for investors, he says.
“I’m not a fan of mean reversion as a way to invest because reverting to the mean is reverting to something that has happened in the past,” he says.
“That is very good if there is no structural change in the marketplace, such as an industrial revolution or now an information technology revolution that changes the world around us and changes the types of means we look at.
“When you look at the geopolitical instability [today], the mean that you would want to take into consideration is the mean that existed somewhere between 1900 and 1932, because that is really a more representative period in terms of debt, central banking, geopolitics and political polarity.
“So I feel mean reversion is looking through the rear-view mirror as opposed to some kind of concept of a value reversion where value takes into account the investors’ best estimate of how structural change might impact the value of an asset or of an asset class.
“Now, this is a nuanced distinction because often there is not a lot of distinction between the two. It is just when there is some type of regime shift that I find that the mean reversion concept is problematic.”
Momentum versus Value
The distorting impact of monetary easing has created an environment that is better suited to growth and momentum strategies than value strategies. But Singer points out fundamental value investors like him don’t completely ignore momentum drivers.
“Momentum is focused a lot more on the timing of the investment decisions, which is important even if you are a fundamental investor,” he says.
“You just don’t want to look at something and say ‘it is expensive and let’s just sell it’, because it can get a lot more expensive on its way to reversion to its fundamental value.
“We have to take advantage over every single piece of information that we have out there and short-term momentum is an important piece of information to take into account.”