Mean Reversion Man

Mean reversion man says sell that which is overvalued, and buy that which is undervalued.

Thanks mean reversion man, you're a great help!

What is overvalued and what is undervalued? I dunno. But to garner a little perspective on that issue, I analogized that just as the global economy had significant structural imbalances, so to the domestic economy has probably got a few sectoral imbalances. We heard from Jim Chanos last week that he thought tertiary education, healthcare, defense and financial services had grown at growth rates greater than what was sustainable and so they were probably candidates for some sort of mean reversion (predicated upon govt intervention of some sort).

That got me curious. Does that thesis play out in the national accounts? The answer is yes, no and dunno.

I took a mosy on over to the US Bureau of Economic Analysis and dialed up the numbers for GDP by Industry from 1987-2007. I compared the current proportion of the economy for each industry with its long term average and sort to identify anomalies by seeing which sectors were outside of their one and two standard deviation ranges.

Interestingly, Mining was running 2 std dev above its long term average, with much of that change coming in the last year of the data. Perhaps not surprisingly, Petroleum & Coal is also running 2 std dev higher than long term average, as are Information & Data Processing and Management of Companies & Enterprises. I can see a little mean reversion going on in some of those sectors.

On the flip side, Agriculture, Forestry, Fishing & Hunting is running 2 std dev below its long term avg. contribution to the economy, along with Electrical Equipment, Appliances & Components and Retail Trade.*

And yes, education, healthcare, and financial services were all running one standard deviation greater than their long term average contribution to the economy. Defense was lumped into the govt spending category which wasn't, as of the date of the data, much different from its historic average.


* That one surprised me. I'm not sure of the definition of Retail Trade but I'll have to look it up.