Mean reversion in the stock market is an 'optical illusion' 😵‍💫

No wonder why we don’t hear about people consistently beating the market by trading mean reversion 🤦‍♂️

My copy of “Triumph of the Optimists.” (Photo: Sam Ro)

Earlier this month, UBS published the 2025 edition of its “Global Investment Returns Yearbook.”

The 294-page encyclopedic review of historical financial market data is authored by Professors Paul Marsh, Mike Staunton, and Elroy Dimson, who have been updating the compendium annually since 2000. Some of us own a hard copy of the 2002 edition titled, “Triumph of the Optimists.”

In their latest update, the authors resurfaced their past analysis that refuted the idea that stock market returns are mean reverting. In other words, it’s no sure thing that periods of strong returns must be followed by periods of weak returns, and vice versa. From the report (emphasis added):

It is often argued that the risk of equities declines when the investment horizon is long, because equity returns are said to revert to the mean. Such mean reversion would not only reduce risk but could provide timing signals that allow investors to boost returns. In 2013 we wrote about mean reversion (Dimson, Marsh and Staunton (2013a)).

We concluded that the popular evidence for mean reversion is an “optical illusion” that employs hindsight. We used the Yearbook’s global dataset to analyze the evidence on return predictability in the absence of any look-ahead bias. We examined the profitability of buying shares when the cyclically adjusted price/earnings (CAPE) or cyclically adjusted price/dividend ratio (CAPD) looks cheap based solely on preceding data. We found that the evidence on mean reversion is weak. Market-timing strategies based on mean reversion typically gave lower, not higher, returns.

These conclusions are consistent with other work we’ve discussed showing that recent returns tell you almost nothing about where the stock market is headed next. See here, here, and here.

The 2013 edition of the “Yearbook” includes an 11-page chapter rigorously scrutinizing the academic research on financial market returns, including work examining the role of valuation ratios in investing.