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Stocks to Revert to the Mean in 2021

Growth stocks are reverting to the mean, they’re down 30 to 40% from their all time highs, while value stocks have received the baton and running with it due to impending sky high inflation and 10 year bond interest rates increases from their all time lows in 2020. 

The mean-reversion trade—searching for out-of-favor businesses in out-of-favor industries that the market had given up on due to temporary impairments in the company’s earning power. These types of investments were the fertile field of contrarian investors who refused to let behavioral bias affect their judgment on a company’s prospects.

Value stocks should see their earnings power benefit more from an economic recovery. Price discrepancies between growth and value have reached extreme levels. There is also the potential for fiscal stimulus and economic recovery to engender higher inflation and a rise in interest rates. Higher interest rates have a disproportionately negative effect on assets with longer duration cash flows, and since the valuations of growth stocks depend on cash flows expected far into the future, the belief is that higher interest rates will cause capital to move incrementally into cheaper shares with cash flows of shorter duration. 

Put On A Business Analyst Hat

Exploiting mispricing in the 21st century will depend more on understanding the convexity of outcomes not yet visible. Avoiding mistakes will require an understanding of fragility to future states not easily understood by the market. This will require sharp business analytical skills. More importantly, it will require knowledge of how human biases cause this type of convexity and concavity to become misunderstood and mispriced. Being able to properly calculate an enterprise value and compare it to some value driver will no longer be sufficient to get the job done.

 

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4 Replies to “Reversion to the Mean”

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