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When Gurus Go Wrong ...
Every decade spawns market gurus who make a few correct calls, get media attention, then fizzle out.
In the 1960s, we had Gerry Tsai and Fred Carr, mutual-fund gunslingers. In the 1970s, we had Joe Granville and Henry Kaufmann. In the 1980s, it was Robert Prechter and Elaine Garzarelli.
The 1990s had the high-flying Internet stock managers. Today, Nouriel Roubini and Meredith Whitney are the rage.
But why do all the gurus eventually stumble? They stumble because it is very difficult to consistently pick winners, and it is very difficult to accurately interpret market-moving information. Let's look at these two issues in a little more detail.
You can't consistently pick winners. We all try, and billions of dollars a year are spent on market research.
Is that rationale? Let me interject a little history here. In 1900, a French mathematician named Louis Bachelier completed his doctoral dissertation on "The Theory of Speculation." This work tried to explain why the stock market behaves as it does. Bachelier used complicated mathematical formulas to reach his conclusions, but they can be summarized as follows:
· There are so many factors that influence stock prices (past, present and discounted future events), that it is impossible to develop a mathematical model.
· There are so many opinions on stocks that at any given time; there are buyers who believe in a price increase, and sellers who believe in a price decrease. Since there's no reason to believe that the buyers are smarter than the sellers -- or vice versa -- then, at any given instant, the expected change in a stock's price is zero. There are just as many buyers as sellers, and neither one has better information.
· If you agree with the last item, then the mathematical expected return to a speculator is zero -- a "fair game."
· If you agree with the last two items, then the market believes that the current stock price is the true price. If the market didn't believe that, then it would quote another price that is either higher or lower.
According to Bachelier, a stock's price will change only when there's a good reason, such as new information. But nobody knows whether this information will cause the price to go up or down; hence, we have a 50-50 chance of an up or down move.
And probability theory says, under such conditions, one out of 1,000 will make 10 accurate calls in a row. But the odds will eventually catch up with them, hence the fizzle.
You can't accurately interpret market information. Even if you knew one day in advance what the nonfarm payroll numbers were going to be, or whether the Fed was going to change interest rates, it would still be difficult to trade with that information.
The problem is that we would have to know what "the market" was expecting, how "the market" interpreted the information and how quickly "the market" assimilated it. That's impossible to do without surveying every market participant.
Even if you did that survey, their minds could change.
In the end, we're back to the basics. Instead of trying to hit home runs, we look for singles and doubles. This strategy may not put us on the cover of Money magazine, but it may help us meet clients' objectives.
Michael L. Schwartz, RFC, CFS, CSA, is president of a Jenkintown-based wealth management firm. He can be reached at 215-886-2122 or [email protected].