In the field of investing, a great deal of thinking has historically been based on the idea that markets naturally mean-revert to “normal” levels. For example, when commodity prices are high, we expect new supplies will be brought on line to bring prices down. And when stock prices are low, we expect new buyers will enter the market and drive prices up. In this mean-reverting paradigm, investors expect the future to be largely a product of the past.
But this traditional approach has a flaw — it doesn’t consider the impact of changing technology and market conditions. What happens to commodity prices when fracking is introduced? What happens to stock prices when China opens its markets to foreign investors?
To compensate for this flaw, investors need to factor in forward-looking information, particularly as change accelerates (see chart). The challenge, of course, is that our knowledge of the future is naturally limited, and virtually every one of our forward views will be inaccurate, at least to some degree.
To manage this uncertainty, it’s a good idea to take a diversified global approach, limit position sizes, and engage in ongoing research to take advantage of strategic and/or thematic investment opportunities. But above all, investors must be flexible and adjust their views as circumstances change — because in our increasingly dynamic world, they almost certainly will.