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Subject:  Re: Security Analysis Dead? Date:  9/29/2003  7:01 PM
Author:  solasis Number:  1681 of 1933

its a bit remarkable that after the 1994-2003 period anyone would still push for perfectly efficient markets........ consider that
in 1994 we experienced the worst US treasury bond selloff in history
in 1997 we experienced the worst disruption in the currency markets since bretton woods
in 1998 we experienced an unprecedented meltdown in emerging market debt and LTCM
in 1995-1999 the US stock market experienced for the first time in its history 5 years in a row of greater than 20% Y-O-Y gains
in 2000-03 the US stock market experienced three down years in a row for the first time in 70 years and only the third time in its history.
in 2001-2003 impairments of publicly traded secured debt (due to bankruptcy and reorganizations) were off the scale compared to previous recessions.
in 2001 copper and other base metals hit all time lows, inflation adjusted, lower than 1932
in 2000-2003 annual and quarterly oil and gas price volatility has reached all time highs

in summary, almost every major market segment has experienced some form of record impairment or disruption or 'crisis' in the past 10 years. if anything, the lesson seems to be that if we have smooth sailing in the markets wait around for a year and a crisis of some fashion somewhere in the markets will show up. this is hardly a case for efficiency.

several factors to consider here.
1. compensation and reward systems for professional money managers
2. highly skewed distribution of investment capital among all participants
3. varying time horizons among participants
4. varying access to information, and across time
5. varying competencies (galton)
6. complex-adaptive system managed by a bureaucracy with monopolistic charter (fed)
7. well demonstrated that certain parties do earn excess returns consistently (NYSE specialists, tort lawyers, some underwriters) in other words the vigorish must be paid by someone (marty whitman is fond of saying individual investors and fund managers pay for lunch on wall street)
8. efficiency, even in theory, relies on the notion of perfect competition (everyone must be trying to earn excess return), yet as you state, many people,like malkiel believe it is futile to even try.
9. uncertainty, not in the heisenberg sense but in terms of future estimations, make risk estimates in-precise

but in any case the zen of efficiency is this

as the number of participants that believe in efficiency increases,
the amount of capital dedicated to outperforming the averages falls,
competition for excess return drops,
the market becomes less efficient.

it is highly beneficial for those of us who do security analysis to have many other participants be price insensitive. the believers in efficiency with their dollar cost averaging and relative bond/stock weighting adjustments, will always be there to buy from us when we want to sell and to sell to us when we want to buy. having a large portion of the market ecosystem believing that it is futile to even try is a tremendous competitive advantage. it is like playing a baseball team with 3 players who will step up to the plate and never swing the bat no matter how they are pitched.

however, it is always very good to challenge ones basic assumptions now and then. i think very few here would deny that the average non-professional would be better off with dollar cost averaging into low cost index funds than a series of selective speculations. however, if you are interested in pursuing a line of questioning as to why markets may or may not be efficient, instead of delving into various methods of stock selection, financial statement analysis, acounting, valuation methods, etc, i would suggest a line of inquiry in behavioral finance as the first step in that journey. also some simple biological principles help to put matters into proper perspective. such as natural selection. note how the studies which purport to show how the majority of money managers underperform their benchmarks do not segregate performance by years of experience. why should we be surprised that the average aggregate performance be below the market? isn't that typical of most eco-systems where advantage accrues to the winners (in this case capital).

good luck.


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