TAG | efficient market hypothesis
12
Why Burton G. Malkiel is More Right Than Wrong
0 Comments | Posted by Alexander Green in Alexander Green
Why Burton G. Malkiel is More Right Than Wrong
by Alexander Green, Chief Investment Strategist
Monday, July 12, 2010: Issue #1299
At FreedomFest in Las Vegas last week, I debated Burton G. Malkiel, author of the investment classic A Random Walk Down Wall Street.
Malkiel is one of just a few men alive who has profoundly affected modern investment thinking. And his position is straightforward.
He believes that rational, self-interested investors take all public information and immediately incorporate it into the price of stocks. (This is where we get the term “efficient market.”)
He therefore concludes that market timing and security analysis is foolhardy… that it’s simply not possible to beat the market over the long term… and that you’d be well advised to give up that dream and just own a broad selection of index funds.
I actually agree with much of what Malkiel says. Much… but certainly not all.
Irrational Exuberance
For starters, you can count on investors to be self-interested. But rational? Not always. Just take a look at recent history…
- How rational were investors 10 years ago when they bid Internet and technology stocks to the skies, forgoing sales and earnings for financial metrics like “eyeballs” and “web hits?”
- How rational were investors five years ago when they put themselves deeply in hock to flip land, rental properties, vacation homes and condos because “real estate always goes up?”
- How rational were investors when they dumped stocks en masse 16 months ago – with the Dow at 6,500 – and plunked the proceeds into money market funds just as yields reached an all-time low?
It’s true that most investors behave rationally most of the time.
But it’s certainly not true that all (or even most) investors behave rationally all the time. And that creates opportunity.
Let’s take a look at another flaw in the “random walk” argument…
Get the Insider Advantage
Malkiel mentions that investors incorporate all “public information” into the price of stocks. But how about non-public information?
Most investors don’t have access to non-public information, that’s true. But that doesn’t mean no one has access to it.
Some of the best trades I’ve ever made have resulted from visiting a retailer and asking the manager how regional and national sales are going. Are they supposed to talk about these things? Absolutely not. But do they?
Sometimes they do. Gaining a bit of key information by talking to customers, suppliers, competitors and employees can give you an edge.
And how about company insiders? Officers and directors have access to all manner of material, non-public information. That gives them an enormous advantage over ordinary investors. And that’s also why Uncle Sam requires them to file a Form 4 with the SEC, divulging the details of their buys and sells.
If you watch what the insiders are doing, you won’t access the non-public information that they possess. But you’ll certainly know whether they think their companies’ shares are overvalued or undervalued. And that’s crucial information.
A 10-Year Market-Beating Performance
In short, Malkiel is right that it’s difficult to beat the market. But does that mean it’s futile to try?
Not only have men like Warren Buffett and Peter Lynch put the lie to that line of thinking, so has our own Oxford Club Trading Portfolio. The independent Hulbert Financial Digest confirms that we’ve beaten the market by a wide margin over the past decade.
But while Malkiel is wrong on some crucial points, he is absolutely right on several others. For example…
- He believes it’s a fool’s errand to try to time the market. I agree.
- He insists that an index fund will outperform the vast majority of actively managed funds over time. He’s right. They have and almost certainly will.
- He argues that index funds provide a big performance boost due to cost-efficiency and tax-efficiency. Right again – and this is far more important over the long haul than most investors realize.
In short, I agree with Malkiel far more than I disagree with him. His research – and similar work by John Bogle, William Bernstein and others – has had a profound impact on the development of my own investment philosophy. In fact, our Gone Fishin’ Portfolio is the very embodiment of much of what he espouses.
And Malkiel may be surprised to learn that this portfolio has beaten the S&P 500 – with far less risk than being fully invested in stocks – every year for over a decade.
I’d call that a non-random success.
Good investing,
Alexander Green
6
Why the Euro Has Further to Tumble
0 Comments | Posted by Alexander Green in Alexander Green
Why the Euro Has Further to Tumble
by Alexander Green, Chief Investment Strategist
Thursday, May 6, 2010: Issue #1254
Being a contrarian is a lonely business.
If you’re a regular reader, you’ll know that ordinarily, I am market neutral on stocks, bonds, currencies and commodities.
The truth is that markets are reasonably efficient. So most years, I don’t stick my neck out and make any market calls on any asset class.
That’s because the vast majority of the time, most assets are neither grossly undervalued, nor wildly overvalued. Rational, self-interested investors keep prices close to true value.
But I am not an efficient market theorist. Investors are always self-interested, yes. But they are not always rational. And I most certainly do not believe that all publicly traded securities are efficiently priced all the time.
That would be lunacy…
Anomalies develop (and opportunities alongside them). Sometimes, these anomalies develop into outright bubbles. When that happens, you will always see eye-popping valuations paired with extreme sentiment. (In other words, sky-high prices and unbridled optimism or rock-bottom prices with extreme pessimism.)
What surprises me is how few investors recognize a bubble, even when it’s right under their nose and they have many thousands of dollars at risk…
Bubble Watch
For example…
- When I warned about the dangers of Internet stocks over a decade ago – I actually quit my Wall Street firm to take possession of my soaring pension shares – most respondents told me I was clearly ill-equipped to recognize the nature of opportunities in “the New Era.”
- Readers similarly scoffed at my warnings about the housing market five years ago. “Real estate always goes up,” they reminded me.
- At $150 a barrel, I wrote a column calling oil “The Mother of All Bubbles.” Demand was already waning and supply was rising as oil hit a new all-time high on various “peak oil” theories. It then quickly lost nearly two-thirds of its value.
- Five months ago – again, right here in Investment U – I predicted that the much-maligned dollar would soar against the euro. And yet again, my readers insisted that I was grossly mistaken and that a weaker dollar was “the ultimate no-brainer.”
Except it wasn’t…
Europe’s Monetary Policy Mish-Mash
Today, the euro hit a 14-month low against the dollar ($1.2689) on increasing recognition that Greece’s fiscal problems are bigger than expected, more expensive than expected and potentially contagious.
Trust me, this is far from over. The 16-member states in the Eurozone are about to start bickering like an old couple that has locked the keys in the car.
Understandably, weaker states don’t like having their economic policies dictated from Frankfurt. And stronger states don’t like spending billions to bail out their profligate brethren from years of fiscal mismanagement.
“Preposterous” Expectations for the Euro Against the Dollar
When the euro was born on January 1, 1999, skeptics rightly worried that the then-11-member states were too divergent to share a single currency and monetary policy.
These fears were well-founded. And the euro promptly plunged on world currency markets to well under $0.90. Today, we know that problems among member states aren’t just possible… not just probable… but right here, stinking to high heaven on our doorstep.
Yet the euro is still trading around $1.27.
Expect it to hit $1.10 by the end of this year – and trade at parity with the dollar sometime next year.
Sounds preposterous? Yes, so I’ve heard.
Good investing,
Alexander Green
Editor’s Note: Find out how The Oxford Club’s “market neutral” investment approach, combined with a keen eye for lucrative contrarian recommendations, led the Hulbert Financial Digest to rank the group’s Communiqué in the top five investment newsletters over the past 10 years.
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