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THE MIDDLE OF THE ROAD: A
PERSONAL VIEWPOINT
Let’s first briefly recap the diametrically opposed viewpoints
about the functioning of the stock market. The view of most
investment managers is that professionals certainly
outperform all amateur and casual investors in managing
money. Much of the academic community, on the other hand,
believes that professionally managed investment portfolios
cannot outperform randomly selected portfolios of stocks
with equivalent risk characteristics. Random walkers claim
that the stock market adjusts so quickly to new information
that amateurs buying at current prices can do just as well as
the pros. Thus, the value of professional stock pickers’
advice is nil.
I walk a middle road. I believe that investors might
reconsider their faith in professional advisers, but I am not
ready to damn the entire field. Although it is abundantly clear
that the pros do not consistently beat the averages, I must
admit that exceptions to the rule of the efficient market exist.
Well, a few. Although the preponderance of statistical
evidence supports the view that market efficiency is high,
some gremlins are lurking about that harry the efficient-
market theory and make it impossible for anyone to state that
the theory is conclusively demonstrated. Finding
inconsistencies in the efficient-market theory became such a
cottage industry during the 1990s and early 2000s that I will
devote an entire chapter (chapter 11) to the market anomalies
and so-called predictable patterns that have been uncovered.
Moreover, I worry about accepting all the tenets of the
efficient-market theory. As the quote from Paul Samuelson
indicates, the theory holds that, at any time, stocks sell at the
best estimates of their intrinsic values. Thus, uninformed
investors buying at the existing prices are really getting full
value for their money, whatever securities they purchase.
This line of reasoning is uncomfortably close to that of the
“greater fool” theory. We have seen ample evidence in Part
One that stocks sometimes do not sell on the basis of
anyone’s estimate of value (as hard as this is to measure)—
that purchasers are often swept up in waves of frenzy. It is
true that the market pros were largely responsible for several
twentieth-century speculative crazes, including the turn-of-
the-century Internet bubble. But the existence of such
psychological influences on market prices at least raises the
possibility that investors may not want to accept the current
tableau of market prices as being the best reflection of
intrinsic values.
Another fragile assumption is that news travels
instantaneously. I doubt that there will ever be a time when
all useful inside information is immediately disclosed to
everybody. Indeed, even if it can be argued that all relevant
news for the major stocks followed by institutional investors
is quickly reflected in their prices, it may well be that this is
not the case for all the thousands of small companies that are
not closely followed by the pros. Moreover, the efficient-
market theory implies that no one possesses monopolistic
power over the market and that stock recommendations based
on unfounded beliefs do not lead to large buying. But firms
specializing in research services and various institutional
investors wield considerable power in the market and can
direct tremendous money flows in and out of stocks. In this
environment, it is quite possible that erroneous beliefs about
a stock by some professionals can for a considerable time be
self-fulfilling.
Finally, there is the enormous difficulty of translating
known information about a stock into an estimate of true
value. We have seen that the major determinants of a stock’s
value concern the extent and duration of its growth path far
into the future. Estimating this is extraordinarily difficult, and
there is considerable scope for an individual with superior
intellect and judgment to turn in a superior performance.
But although I believe in the possibility of superior
professional investment performance, the evidence we have
thus far does not support the view that such competence
exists; and although I may be excommunicated from some
academic sects because of my only lukewarm endorsement of
the semi-strong and particularly the strong form of the
efficient-market theory, I make no effort to disguise my
heresy in the financial church. It is clear that if there are
exceptional financial managers, they are very rare, and there is
no way of telling in advance who they will be. This is a fact
of life with which both individual and institutional investors
have to deal.
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