Battlepanda: Bullisht


Always trying to figure things out with the minimum of bullshit and the maximum of belligerence.

Wednesday, November 30, 2005


Don't get me wrong. I think the proponents of the efficient market theory did a lot of good in terms of calling bullshit on mutual funds and expensive, worthless money managers. And I certainly plan to keep my spare chunk o change in an index fund, perhaps with a few small stakes in individual companies just for the yuk of it. But the underlying premise of the E.M.T. -- that you can never consistently do better than the market because the market in the aggregate is a rational actor and never over or underprices stocks -- is just plain nuts. Forget about Warren Buffet or the Dot Com boom/bust. I consider the below exibit A when it comes to why E.M.T. is a crock. From the Financial Times via Daniel Gross:
US retail investors have regained their optimism in the stock market and are newly confident in the securities industry, according to a survey by Sanford Bernstein. However, they also appear to be deluded about the success of their own investments, with the average investor reporting that their US equity portfolio has grown 9.6 per cent over the past 12 months.

This is a statistical impossibility, as the S&P 500 benchmark index has gained only 5.5 per cent over that time, and shows that investors continue to be uninformed.
Now, I understand that the E.M.T. does not say that individuals are rational, quite the opposite. It simply posits that there are enough rational individuals in the stock market to keep everything priced correctly through arbitrage. But I don't even think that can be true, if the average investor is so deluded as to overvalue their returns by almost 80%. There is a lot of dumb money swilling around the stock markets. And even people who do have the information to price stocks properly based on fundamentals find it difficult to take advantage of that knowledge given the dizzying short-term irrationalities of the stock market. Here's a very perceptive bit from Jane Galt, who's been banging this drum for a while:

Bubbles generally become apparent to experts years before they pop. Contrary to popular opinion, many people on Wall Street knew that stock prices were irrational long before the bubble collapsed.

So why didn't they say so? Well, some of them wanted to sell fat IPOs to gullible suckers. But many of them did say so, only no one paid attention. The problem with newspapers isn't that they need advertisers; it's that they have incredibly short attention spans. Journalists tend to cover a beat for a few years, and then move onto the next thing; that's how you move up in a media organization. Thus, they tend to check expert's predictions against months, rather than years, of data. And in the short run, bearish experts were wrong.

It is a maxim of traders that "the market can stay irrational longer than you can stay solvent"; that is why few people on Wall Street tried to act on their knowlege that the stock market was overvalued by selling short. They knew it was going to bust, but they didn't know when, meaning that they couldn't be sure they'd be able to cover their short trades long enough to make a profit