George Soros, the master of markets, gave a very interesting speech at the INET in Berlin. Not only are we trapped in the malfunctions of the Newtonian economic theories, but we are facing the worst ahead of us.
Ever since the Crash of 2008 there has been a widespread recognition, both among economists and the general public,that economic theory has failed. But there is no similar consensus, even among participants of this conference, on the nature and implications of that failure. As a sponsor of INET I am delighted because it shows that INET is open to widely different strands of new economic thinking. But I am not only a sponsor; I am also the proponent of an alternative interpretation of financial markets and today that is what I should like to talk about.
Must watch video and full speech below.
By Neel Kashkari of PIMCO.
These Newtonian beliefs also affect how many people think about investing. “Mean reversion” is the investment world’s version of “what goes up must come down.” It’s usually a pretty good rule. Mean reversion suggested that the extraordinary price to earnings multiples of technology stocks in the late 1990s couldn’t last; they would eventually revert to historical average valuations. Similarly, mean reversion suggested that house price increases in the U.S. in the mid-2000s weren’t sustainable. They didn’t last either.
But is mean reversion always right? In 2000 mean reversion would have suggested the bull market for bonds would be over. Interest rates couldn’t stay low, let alone fall further, could they? But here we are in 2012 and we’re not predicting a bear market any time soon.
In tension with mean reversion is Newton’s First Law: A body at rest tends to stay at rest. In investment parlance there needs to be a catalyst to force the system to revert to the mean. Left alone, it may continue in its elevated state for a long time.
The timing of that reversion matters: Just because someone can identify a bubble doesn’t mean they can make money from their insight. People who shorted tech stocks too early may have lost a lot of money while the bubble kept expanding.