Collapse of Market Fundamentalism

Most of the investment methodologies are built on a theory called market fundamentalism. Market fundamentalism suggests that markets are self-correcting and eventually revert to the mean.

Mathematical definition of the theory is based on a simple statistical assumption that deviations from the mean occur in a random fashion and you can calculate a distribution and expect the market to return to the mean over the time. In other words, overshoots from the mean in both directions always offer investment opportunities over a long time.

This theory is wrong. Markets do not revert to the mean always, because the markets are reinforcing. Markets are not perfect and under the right circumstances, trends can feed on themselves.

Under the right macro circumstances like political, economic and social, market fundamentalism appears to work for decades / centuries. But when those major conditions change or no longer exist, your statistical model is refuted in time.

"Buy American, I am", by Warren Buffet. I think the markets are about to make a historical example out of this man who used market fundamentalism successfully for all his life. Survival of the fittest in finance is based on adaptation to the trend created by underlying factors. I do not think he will live long enough to realize it.

Now what all this means for an investor? I think it means this may not be a time to find the next GE to invest for the next 50 years. I think as soon as the market hits a reasonably low P/E, like 8 to 10, it will trade in a 30-50% range until P/E once again justifies further sell off... That is, S&P may rally 30-50% off the lows, this doesn't mean we are getting back to the mean. From an analytical perspective, I know exactly where the mean is and it is impossible to achieve any longer. While we trade in a range, corporate earnings will further decline, this will eventually blossom into another cyclical sell off in coming years.

However, I am thinking this is the time to apply that false market theory to China. I think market fundamentalism will work for China for the next few decades. I am waiting for the right moment to enter that market for the long run.

I expect S&P500 to test 650 in a few days. Tomorrow's open is very important to confirm this.