… is, you guessed it, still a forecast.

Recently, I watched a recorded presentation by Dave Loeper of Wealthcare Capital, and he made a comment that really got under my skin. I might be misquoting him, but he said something along the lines of “mean reversion is really just a fancy term for a market forecast”.

Think about that for a minute.  Really let it sink in.

For those not familiar with the term “mean reversion” it essentially means that the farther and longer something (anything) diverges from its long-term average, the more likely it is that it will move back (or revert) to that average (or mean).  If someone has a clearer or more concise explanation, I welcome you to leave it in the comments below.

Back to the topic … is mean reversion a forecast? I would have to agree that it is.  Whether discussing the market or the weather, we might have a hunch of what will happen in the future, but we really don’t know.  And just because something has diverged from an average, doesn’t mean that it will return to that average in any expected or rational manner.

Let’s expand this concept … for people out there that subscribe to the Fama-French model espoused by Dimensional Fund Advisors (this includes me, by the way), you would generally agree that there is additional expected return, albeit with additional expected risk, to be achieved by overweighting or tilting toward value and small companies.  But isn’t this just another forecast?

Sure, Fama & French have applied exhaustive academic research to demonstrating this value and small cap “premium” in the past, but to hold any expectations for it to continue into the future is still subscribing to a market forecast.

I realize that I might draw some heat for sharing these thoughts, but isn’t it my job as a financial advisor and fiduciary to my clients to ask these questions and challenge the status quo?  Then again, maybe I’m just stating the obvious.

Do I have a better solution or alternative to offer? No, I do not and don’t know that I ever will.

However, I think it’s misleading to ourselves and our clients to demonize market forecasting in any color, shape or form, while at the same time implementing a forecast ourselves.  Investing, by its very nature, involves making some forecast, whether explicit or implicit. If we didn’t think stocks were going to go up over time, which is yet another manner of forecast, why are we investing at all?

I hope this will spark some discussion and I welcome your comments, questions and critiques in the comments section below.

What do you think?