Goldman Sachs Destroys An Investing Myth?

Did Goldman Sachs destroy a persistent myth about investing in stocks? Sam Ro recently suggested such was the case for the “sacred CAPE ratio.”

So, what is the persistent myth that is no more?

“While valuations feature importantly in our toolbox to estimate forward equity returns, we should dispel an oft-repeated myth that equity valuations are mean-reverting.” – Goldman Sachs

As Sam notes in his commentary,

“Many market watchers use above-average CAPE readings as a signal that stocks should underperform or even fall as it reverts back to its long-term mean. But CAPE’s mean doesn’t actually have much pull.

However, here is the key sentence from Goldman’s analysis.

“We have not found any statistical evidence of mean reversion,” the Goldman Sachs analysts wrote. “Equity valuations are a bounded time series: there is some upper bound since valuations cannot reach infinity, and there is a lower bound since valuations cannot go below zero. However, having upper and lower bounds does not imply valuations are stationary and revert to the same long-term mean.”

Goldman Sachs, Goldman Sachs Destroys An Investing Myth?

While the analysis is correct, it obfuscates the more important point of valuations and reversions to the mean.