Tuesday, August 18, 2009

Why the Nitwits Always Win, and the Smarties Always Lose

In his "Jubak's Journal" of August 18, 2009, Jim Jubak writes about the failures of efficient market theory, both it's intellectual failure and it's practical failure in predicting or preventing the great market collapses of the past few years. He concludes the article: "So the strategy I come away with after reading [Justin] Fox is actually very simple: Follow the efficient investing strategies during normal times and invest like a contrarian during the 20% of times that aren't normal. Now if someone will just show me an infallible way to tell the 80% from the 20%."

Obviously, I don't have a way to distinguish between the 80% of normal markets - driven by intelligent and informed self-interest - from the 20% of abnormal markets - driven overwhelmingly by emotion, whether it agrees with reality or not. The difference between myself and Mr. Jubak is that I don't see why I need one, or why I should want one.

At this point, it's quite legitimate to ask why anyone should pay attention to my opinion, the opinion of a nobody, in opposition to that of Jim Jubak, an experienced, well informed investing professional with a lot of expensive technical equipment standing behind him. I will give my usual answer: I am indeed a nobody, but I am a nobody who has been getting an annualized return of roughly 5.8% since I started investing in the middle of 1998, while the S&P 500 has been returning roughly 0.16% since then, and most of the professionals have been doing much worse. And the same basic relationship holds true between my returns and the "market's" return for any reasonable length of time since I have been investing - any period of five years or longer, let's say. Luck? Maybe most of it, but probably not all of it. My brilliance? Certainly not, but Ben Graham's clear-headedness may have something to do with it.

Back to our point of discussion: Why does Jim Jubak regret not being to understand what's driving the market over the short and medium term, while I just don't care? For a reason which Benjamin Graham enunciated in 1949, in the famous concept of "Mr. Market". Mr. Market, the gentleman who prices securities in the short term - and one always buys or sells in the short term; one rarely intends to place a buy or sell order to be executed five years from now - is often wrong, and it is often best to ignore him, buying securities on the basis of one's own estimation of their intrinsic value relative to price. The nobodies always plod along crunching the same old price-to-future-returns numbers, ignoring the "market" - and have tended to be right over the last few decades, while often looking like nitwits over the short term - while the smarties try to understand the market, and often lose.

So not knowing what drives the market isn't the end of the world.


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