Burton Malkiel Still Bullish After All These Years
Burton Malkiel’s influence upon stock market thinking has been remarkable. He’s still promoting market randomness at age 87, and remains pretty bullish.
Former Princeton economic professor Burton Malkiel has written a few books on investing, including the iconic A Random Walk Down Wall St: The Time-Tested Strategy for Successful Investing. He’s also the father of what has been come to be known as the efficient market hypotheses, which he bases his random walk theory primarily on, even though both theories crumble under even the most cursory of examination.
Malkiel’s ideas are often used as a punching bag by many who do not share his beliefs about the randomness of securities trading, which are so easily dispatched that it hardly seems worthy of piling on, but there may be a lesson for investors out there who may actually harbor at least some of his beliefs and may therefore benefit from seeing some light shed upon them.
We might think that anyone who sees the price change of securities as being random would be forced to conclude that there is nothing to be gained from trading or investing, as there really wouldn’t be any point. However, this leaves you unable to dodge the first big punch, the one that shows that stock prices have gone up pretty well over time, which in itself completely destroys this theory.
However, oddly enough, Malkiel is a lifelong bull, and believes strongly that we can make money investing, from the average stock price not being random but set upon an upward course. You can’t believe that and believe that these prices are random though, unless you just embrace the contradiction that is. Malkiel has never had any trouble with that aspect.
Malkiel still recommends that people buy and hold index funds to this day, which aren’t random at all, but somehow everything else is. We need to start out by looking into whether there is randomness at all with securities prices though, and as it turns out, there is none whatsoever present in any aspect or degree.
When you look at the movement in price of any market or any security, it becomes very obvious that we are not looking at random patterns, whether we’re looking at a chart showing a century of prices or one showing just minutes of trading. However, that’s not even the killing blow.
We all have a pretty good idea of what random is, the results of a coin flip for instance, with a perfectly random coin. Randomness is the complete lack of influence, and this is actually how it’s defined, and if for instance you made the coin a little unbalanced, it wouldn’t be random anymore, and its randomness would be diminished by the amount of influence.
Securities trading arises purely from agency, people buying and selling them, and they don’t do this randomly, they instead are acting purposely. There has not been a single trade ever that involved any randomness, as people do these things because they expect to get some kind of benefit out of the trade, mistakenly or not. People see the price going up, they buy, or see it going down and sell, or act upon a number of other trading ideas.
This type of activity does not produce random results, and far from it, the actions behind them are not the least bit random. It’s not that index funds are not random but every other security is, it is not that the long term isn’t random but shorter time periods are, as none of this would be even theoretically possible, unless you are clinging to absurd theories.
If you are out to promote index fund investing over other forms though, and don’t have the good fortune to realize how foolish your ideas are, you might want to try. Not that it really matters, but Malkiel has been a principal in Vanguard since the early days, and his infamous random walk book and the birth of the index fund occurred at exactly the same time.
It doesn’t matter if we want to see his views as propaganda or not though, because even pointing this our would be a means of discrediting his views, but that requires that there be some sort of credibility involved to discredit in the first place, which is not needed at all here.
There are actually some good reasons why some investors may wish to invest in index funds, but the fact that they are believed by Malkiel as the only non-random way to invest doesn’t contribute to these reasons of course. It would have been pretty easy to come up with some better ones, with the biggest one being that few of these funds beat the market consistently, although some do, even though Malkiel does not consider this to be possible.
The idea that long-term movements in price are not random but shorter-term movements are random is pretty amusing though, because this is theoretically impossible. You can’t get predictable events from the sum of non-predictable events.
His Famous Book is Just a Pitch for Index Funds
Apparently, before the dawn of index funds, it wouldn’t have been possible to make money from investing or trading in stocks, and we apparently have Burton Malkiel and Jack Bogle, who together created these funds, to thank for our being able to do this. The fact that a lot of money has been made by investors picking their own stocks and even daring to do something other than just hold them forever, or by traders who move in and out of positions very frequently, doesn’t matter it would seem.
Many investors don’t know anything about investing and may therefore be subject to being duped by these theories. The idea that you can’t beat the market consistently is one of these, and a lot of people just take this on faith.
If you couldn’t beat the market consistently, all traders would simply lose money, as they do not just shoot for market returns and the ones who can’t do this just go broke quickly. Plenty do succeed, the ones that do know what they are doing, and can make tremendous amounts of money, achieving returns far in excess of the market. Traders just laugh and then turn away from this foolishness, although far too many amateur investors are taken in by them to some degree at least.
You probably do have to be a trader to fully appreciate the humor in one of Malkiel’s recent quotes. He admits that “we do know there are strategies based on momentum that work from time to time, and then there’s a momentum crash. People in general are much better off simply staying the course and being buy-and-hold investors.”
We’re not sure what a momentum crash is supposed to be, and we can only presume that he is talking about a reversal. Someone needs to tell him that we make money on that side of things as well, like the momentum crash we just got, a random event surely. Momentum crashes are momentum as well, and often, even stronger momentum.
It’s much more than traders that attack Malkiel’s ideas though. Warren Buffett is as far from a trader as you could possibly get, and he famously clashed with Malkiel back in 1984. Buffett slayed him, not that this is any sort of feat, but Malkiel simply chose to ignore Buffett’s arguments, not that he could have done much otherwise.
Warren Buffett sure did pretty well over the years by tinkering with randomness, as this brings us to perhaps the funniest upshot of Malkiel’s theories, the fact that you can make money from stocks if you buy a basket of them, any basket presumably, but you cannot do this by picking the stocks in your own basket. You have to leave this to people like Mr. Dow with his magic 30 or some other assortment that comes prepackaged for you
The fact that these indexes aren’t the market at all, and are just a slice of it, isn’t considered by Malkiel either. We’d need to own every stock out there to own the stock market. Indexes are just another sample of it, as any assortment that we choose ourselves would.
Somehow, the people who select the stocks to go into particular indexes have the magical insight to figure out which stocks to go with to get around the natural randomness involved in all of this, and even though this makes no sense, perhaps there is some magic in that old silk hat they found, or in the alternative, an old man that is just as confused after almost 50 years of promoting this stuff.
Index Funds Remove the Element of Skill, But Skill Matters, if You Have Some
Buffett did pretty well over the years in spite of trying to tame randomness, even though he or anyone else is not supposed to be able to according to, it’s not even supposed to according to Malkiel. A lot of people have done very well without needing to rely on index funds, including long-term buy and hold folks, investors who have moved in and out of their positions at various times, as well as traders of various sorts, including institutional traders who make their employers billions of dollars a year.
People also make money buying and holding index funds, and you only need to look at the charts of these indexes to figure out how. The centerpiece of Malkiel’s view though is that we cannot ever tell the difference between a good and bad stock, between Amazon and Macy’s for example, between Netflix and oil stocks, between anything.
Malkiel takes on all comers here, those who trade based upon price action exclusively, those like Buffett who invest on fundamentals, the quants who program millions of stock trades a day only lasting for microseconds and make a lot of money from that, everyone in fact other than buy and hold index fund investors. There is nothing to do here but shake your head and make sure that you are not similarly mixed up.
Some theories can only be partially tested, and some cannot be tested at all, but this one can be, and it falls completely on its face. It’s even hard to imagine anyone believing in this who does not also believe in the Easter Bunny, although the bunny is the more credible story of the two since it’s at least possible in theory, a rabbit from a more advanced planet who came to us to promote the consumption of candy and can be in multiple places at the same time, a quantum bunny perhaps.
Malkiel also believes in the efficient market theory, and since this is supposed to provide a basis for his random walk theory, with given that both ideas were conceived sitting on the same toadstool, it’s also worth mentioning.
According to this one, the price of a stock at any given time is the sum of all the information in the world about it. The market does price in events, but the very fact that it does so over time is enough to squash this one.
There’s more though, such as the fact that stock prices are guided by things other than information, momentum for instance. He even admits that it is real, even though the efficient market theory does not allow for the existence of momentum, because the price is already efficient and momentum without any new information would render it inefficient, and it is never inefficient, in the fairy tale version at least.
Malkiel remains a major influence upon the investment world, perhaps to a far greater degree than we may realize. The idea that you can’t beat the market is one that will far outlive the professor, just like index funds will. If you are told you can’t, and you believe it, you surely won’t.
Index funds beat most actively managed funds because those who run active funds generally do not know enough about what they are doing, and do not select for performance that well, and certainly do not manage their positions this way either. It’s very hard to do anyway, and it’s not as if these funds could smell a panic coming and mouse click their way to safety like we could.
They tell you that their goal is to beat the market, but their actions say otherwise, generously peppering their portfolios with all sorts of junk stocks that are supposed to be due, and hoping that bad stocks will somehow turn good, and especially refusing to accept that they were wrong as their results fail to achieve their objectives.
Most investors don’t realize that you actually can pick good stocks and manage them properly and do considerably better than just going with a basket which does not benefit from any attention at all. Even picking stocks randomly would do no worse in the long run, but there are some things that we can do to help ourselves here.
We have to start wondering about this first, otherwise we’ll just let ourselves be confused and be stuck following economists like Malkiel. This isn’t the worst thing though, as you still make some decent money this way, but we’ll never know what we give up with this strategy unless we dare to look.
Editor, MarketReview.com
Eric has a deep understanding of what moves prices and how we can predict them to take advantage. He also understands why so many traders fail and how they may help themselves.
Contact Eric: eric@marketreview.com
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