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market conditions

The Meanest Reversion: BABIP and CAPE

August 9, 2017 by Brendan Mullooly, CFP®

“The meanest reversion is the one that refuses to revert in a timely enough fashion.” – Josh Brown

I recently had a conversation with a friend who I play fantasy baseball with. We like to bounce ideas off each other, and occasionally commiserate when things don’t work out. My friend was bummed out because a few weeks ago he dropped Chris Taylor of the Dodgers. Since his move, Taylor has continued to rake. The rationale for cutting him was based largely on a sabermetric stat called BABIP.

BABIP stands for “Batting Average on Balls in Play”. I’ll borrow a graphic from Fangraphs to define BABIP:

BABIP
http://www.fangraphs.com/library/offense/babip/

As the definition states, a .300 BABIP is about league average. This means roughly 30% of balls in play go for hits. We also know that the range for BABIP tends to stretch from .230 on the low end to .380 on the high end. Some players have BABIPs consistently better or worse than .300, but not many fall outside of that range.

Back to my friend’s decision. Chris Taylor currently maintains a BABIP of over .400. There have only been four instances in history where a player finished the season with a BABIP over .400.  Knowing that, it seems like a near statistical certainty that Chris Taylor is due to regress, right? While Taylor will likely regress at some point, my friend learned the hard way that it doesn’t have to happen in a timely fashion. It doesn’t even have to happen this season for sure. We just know that it’s highly unlikely he continues at the rate he’s currently at.

Figuring out that something is due for mean reversion is a lot easier than figuring out when that reversion will actually occur. No matter how statistically certain it appears, using mean reversion as a timing tool can be a painful game.

This whole conversation with my friend about BABIP and mean reversion has eerie similarities to the ongoing discussion surrounding the US stock market’s CAPE ratio. For those who don’t know, the CAPE ratio looks at the average inflation-adjusted earnings from the previous ten years to determine how cheap or expensive US stocks are. It’s currently at expensive readings we’ve only seen a few other times in history.

Current CAPE Ratio
http://www.multpl.com/shiller-pe/

Some investors get spooked by data like this and justifiably so. However, stocks have been relatively expensive for a few years now, so what to do with this data isn’t so black and white. It’s not as simple as: stocks are expensive, get out or stocks are cheap, get in. Unfortunately, that tends to be how people want to apply measures like CAPE.

If investors are searching for any one-off signal to make all-in, all-out calls with, they’re in for a lifetime of whipsaw and pain.

Meb Faber put it well when he wrote:

“I tell investors using valuation is a spectrum of future possibilities. While buying expensive markets generally will produce lower future returns, you will have positive outliers. The same for cheap markets, it’s usually a good idea but they can always get cheaper.”

Whether we’re talking about CAPE or BABIP, the real world presents countless factors (known and unknown) that can drive readings. For markets it may be things like GDP, market trend, inflation, interest rates, or corporate profits. For baseball players it could be pitching matchups, stadium effects, or the player’s health. Even statistically reliable indicators will never be fail-safe because we’ll never know precisely what factors are feeding into them or the degree to which they currently matter.

My advice is that if you’re banking on reversion occurring, just remember how mean it can be in the interim.

 

Further reading:

http://mebfaber.com/2014/08/22/everything-you-need-to-know-about-the-cape-ratio/

Filed Under: Asset Management Tagged With: long term investing, market conditions

Tim’s Top Links – 2/23/17

February 23, 2017 by Timothy Mullooly

timThere are things in life you can control, and things you cannot.  It’s become abundantly clear to me that people should spend their time focusing on the things they CAN control.  One of my links today talks about just that.  Many people spend more time thinking about investing, and not enough time thinking about their spending/saving habits.  The markets are out of your control, but how much money you put away each month is 100% in your control.  While the benefits of investing over time are clear, the more controllable exercise would be to focus on getting your spending and saving in line first.

Here’s what I’ve been reading this morning:

‘A Little Can Go A Long Way’ – Michael Batnick – The Irrelevant Investor

‘People Trying To Save Prefer Accounts That Are Hard To Tap’ – Shlomo Benartzi & John Beshears – The Wall Street Journal

‘Technology ETF Squeaks Out Longest-Ever Streak Of Gains’ – Ryan Vlastelica – MarketWatch

’10 Tax Breaks For People Over 50′ – Emily Brandon – U.S. News

‘After Dismal Holiday Season, Fitbit Doesn’t See Things Getting Better In 2017’ – Lauren Gensler – Forbes

ENJOY!

Filed Under: News Tagged With: long term investing, market conditions, personal finance

Tim’s Top Links – 2/22/17

February 22, 2017 by Timothy Mullooly

timIf there’s one thing I strongly believe every human being should be well versed in, it is personal finance.  There are plenty of articles circulating the internet all the way from years ago, to ones even being posted this very second, about personal finance.  However, most of them have the same important message.  You need to have clearly communicated, well documented goals, as well as self-discipline to stick with those goals.  A couple of the articles today deal on those very important topics.  Take a look.

Here’s what I’ve been reading this morning:

’10 Ways To Turn Around Your Finances In 2017′ – Kerri Fivecoat-Campbell – Forbes

’10 Power Ways to Master Self-Discipline’ – Deep Patel – Entrepreneur 

‘Bankrupt Avaya Stops Paying Some Pension Benefits – Lillian Rizzo – The Wall Street Journal (PAYWALL)

‘Factor Zoo or Unicorn Ranch?’ – Gary Antonacci – Dual Momentum

‘Getting Rich vs. Staying Rich’ – Morgan Housel – Collaborative Fund

ENJOY!

Filed Under: News Tagged With: market conditions, personal finance

Tim’s Top Links – 1/11/17

January 11, 2017 by Timothy Mullooly

timThere is certainly a lot of change happening, or about to happen in the United States.  In a matter of days we will have a new President, and regardless of your feelings about the matter, it’s going to happen.  There are certain things, both in and out of the market, that you can control.  The most important thing is to focus on what you can control, and position yourself in the best possible way to make the most of it.  Focusing on things outside of your control is a waste of your time.  This goes for things in every day life, as well as the finance industry.  Just try and keep that in mind as you go about your day. *Steps off soap box*

Here’s what I’ve been reading this morning:

’10 Things You Can’t Learn From a Backtest’ – Ben Carlson – A Wealth Of Common Sense

‘The 401(k) Road to Serfdom’ – Anthony Isola – A Teachable Moment

‘High Paid MBA Types are “Sheep”‘ – Tadas Viskanta – Abnormal Returns

‘Passive Investors – Dumb Money or Smart Money?’ – Cullen Roche – Pragmatic Capitalism

‘How Differences In Composition Distort Market Valuation Differences’ – Lawrence Hamtil – Fortune Financial

ENJOY!

 

Filed Under: News Tagged With: 401k account, market conditions

Mullooly Asset Show Episode 38

July 14, 2016 by Thomas Mullooly

1:17 – I thought the Fed was raising rates, but I just saw a headline that said rates are at all-time lows. What’s going on?

Click here for the transcription of this video

Filed Under: Videos, Financial Planning Tagged With: interest rates, market conditions

Mullooly Asset Show Episode 32

June 15, 2016 by Thomas Mullooly

1:36 – What’s all this talk about Brexit?

Click here for the transcription of this video

Filed Under: Videos, Investor Behavior Tagged With: market conditions

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