I’ve embarked on a perilous journey, to understand the stock market and reap what knowledge might be gleaned from raw experience and the ancient tomes. So far, not so good. Just as I expected, there are directly conflicting theories and no conclusive results.
One of my favorite cartoons is BoJack Horseman. In the cartoon, there’s a talk show called “Hollywoo [sic] Stars and Celebrities: What Do They Know? Do They Know Things?? Let’s Find Out!” I’d like to present my findings in a similar manner.
First up, gurus. Do they know things? I’m going with my gut feeling that they don’t. It’s too easy to be temporarily successful, and then fade into anonymity once that spurious success recedes. Not to mention that once you have a following, you can create your own self fulfilling prophecies / bubbles by telling people a certain stock will rise. Telling people a stock will rise will make people invest in it, making the stock rise.
Now for the guest celebrity, Burton Malkiel, the guy who wrote “A Random Walk Down Wall Street” 50 years ago. He claims that no one knows things and that things are unknowable. There’s a joke, “Two economists are walking down the street. One spots a $100 bill and bends down to pick it up. The other says, ‘Don’t bother, if it was real someone would have already picked it up.’” Malkiel uses that as his modus operandi. According to him, the stock market prices move just like a drunk person walking randomly down wall street. To demonstrate this, he challenges his readers to flip a coin and record the “heads” and +1 and “tails” as -1, and then chart it. I’ve done that with google sheets and a random number generator. To his credit, that purely random chart is indistinguishable from the stock charts I look at. I caught myself looking for patterns in my random chart… and I found them.
It’s the most pessimistic, nihilistic, atheistic philosophy I’ve ever heard of; and I’m a pessimistic, nihilistic, atheist! First of all, if everyone thought like Malkiel and turned their nose up at $100 bills, then the ground would be littered with layers of $100 bills. Opportunities must be out there, even random ones. Second, what is so fundamentally different between the stock market and the labor market? I found two of my jobs through people I knew instead of the traditional hiring process. That special knowledge benefited me over my competitors. That would be considered a market inefficiency. I accept that arbitrage (buy low at one place and sell high at another) is now obsolete for humans to do, but surely there must be patterns or indicators. What is so fundamentally different between the stock market and the universe? The universe is chaotic, but we still find useful patterns. The weather is chaotic, but it’s somewhat predictable (Tucson is hot in the Summer, Chicago is cold in the winter). How can we be certain about what’s knowable or unknowable? Would anyone 100 years ago have predicted that we could know with decent precision that the universe is 13.7B years old? Any claim that something is unknowable is too bold for my taste. I would agree with his self assessment. He, indeed, does not know things.
Next, let’s bring in my basement dwelling friends, the Technical Analysts, or more aptly called Chart Analysts, since there’s nothing technical about it. These people trade stocks purely by the chart, and not by the business model. They are herd followers. If the price is going up, they buy. If it goes down, they sell (or short).There are increasing levels of complexity to their trading strategy, but that’s the essence. I find merit in what they have to say. It’s just a matter of pattern recognition, filtering out noise from the signal in the indicators, and a little luck. What difference does it make if it’s Apple or Ma-and-Pa’s Chicken Shake Inc.? If everyone feels that they’re the “Next Big Thing” then they are. If it’s stupid and it works, it’s not stupid. That being said, I have yet to make it work.
How about everyone’s favorite, the Fundamental Analysts? The shamans divining the Spirit of the Market. The Cohens of the Temple. The Priests receiving word from on high. Those who know esoteric Kabal-secrets. It’s all hogwash if you ask me. They look at the fundamentals of the business to decide if a stock is overvalued or undervalued. The idea is to be more logical and rely less on emotion and less on the market’s whim and follies. The most common indicator is the P/E ratio (the price of the stock compared to the earnings) One sect preaches “Buy low P/E ratio stocks. The price is low compared to it’s earnings implying that the price will rise to match.” The other sect says, “Sell low P/E ratio stocks. The price is low because there is something wrong with the company.” I’m no accountant. I’m not about to dig into their financials and assess the true value of the company. I’ll just outsource that. But if I’m outsourcing it, I still have to find someone reliable. Remember WorldCom, Tyco, and Enron? Where were the accountants before the fraud was announced? How did it escape every single accountant ever? How did their logic serve them there? These people were still victim to the emotional buying frenzy. If these Fundamental Analysts know anything, they must be very specific things.
Entire armies are trained in the barracks of Harvard and Yale to go into stock trading, and then get jobs trading stocks. Is Malkiel trying to tell me that these kids go massively into debt, only to learn how to pick their nose, and then get a job picking their nose? I think not. And these businesses that hire these kids and pay them beaucoup bucks? They must know something. I find it hard to imagine that the stock market is “unknowable.” Someone has to be picking up the $100 bills. Why not me?
What about entrepreneurs and venture capitalists? Someone keeps inventing stuff and making money from it. They noticed a $100 on the ground and took it. They must have known something we didn’t. Facebook caught onto the social network trend. Apple knew how to do user interface. Someone is investing in these companies because there’s something about them that makes them obviously a better choice than another, and it can’t just be randomness.
In conclusion, if there are secrets to the market, why would anyone talk about it? Startup founders have Non-Disclosure Agreements to hand out to everyone they meet. I shall continue my journey of discovery in the market. If I don’t find anything, I’ll let you know.