Comments on the Efficiency of Stock Markets-Becker

It is very difficult for either amateur investors or even professional money managers to do better picking their own stocks than the performance of the major stock indexes, such as the US Dow Jones Industrial Average (DJIA) or the Japanese Nikkei Index. In fact, most investors in active funds do worse than broad stock averages, after netting out what is paid to fund managers. Funds that do better than stock averages for several years are usually taking sizable risks that eventually catch up with them through sporadic sharp falls in the values of their portfolios. This happened to many exotic funds during the present financial crisis. This difficulty in "beating the market" is behind the development of index funds that simply hold a broad portfolio of stocks whose price movements mimic that of the overall indexes. While the difficulty of beating market averages suggests that stock markets are reasonable efficient, conclusions about efficiency are far more complicated when the criterion is whether stock prices are determined by market fundamentals: present and future earnings, interest rates, and the degree of risk associated with earnings and interest rates. On the one hand, prices of individual stocks do very much depend on their present and expected future earnings, interest rates, and their systemic risks- the betas in finance theory. On the other hand, prices of both individual stocks and of aggregate indexes often fluctuate in ways that deviate from the fundamentals. For example, during the Internet bubble, shares of many Internet companies sold for more than $50 or even $100 a share, even though these companies were not only losing money, but had no significant sales. These high prices were supported by radically wrong expectations about the future prospects of these companies. Many of these stocks became worthless, while most surviving Internet stocks lost almost all their prior market value. Even many non-internet stocks were excessively priced during the bubble years, as the stocks in major stock indexes were selling for a while at well over 20 times their earnings. Stock markets are not performing efficiently when stock prices are either too high or too low relative to risk-adjusted discounted earnings. Sometimes, however, it is not easy to determine whether and how much prices deviate from fundamentals. For example, corporate profits were very high when the DJIA peaked in 2008 at 14,200, so that if these profits had continued, this price level did not imply excessive price-earnings ratios. The sharp fall of this index to its present value of about 8000 has been associated with a plummeting of actual and expected earnings, which led to a collapse in financial stocks and in prices of other stocks as well. Perhaps it should have been clear that profits in 2004-07 were too high to be sustainable, but it surely was not apparent to the vast majority of participants. Can one say that individuals and funds are behaving irrationally if they are not shorting stocks, or are not mainly invested in bonds and other assets, when stock prices are much too high relative to fundamentals? Similarly, are investors rational when they are shorting stocks, or investing in other assets than stocks, when stocks are too low relative to fundamentals? The answers are not clear without further information since stocks may remain high (or low) relative to fundamentals for quite a while. Therefore, going long (or short) may also be profitable for a while. To be sure, at some point the day of reckoning always comes when stock markets move much closer to fundamental levels. At that time, persons and funds lose a lot if they are long on stocks when they fall back sharply toward levels determined by fundamentals, or short on stocks when they rise sharply. However, predicting when the reckoning comes may be extremely difficult even for highly rational and far-sighted persons with extensive knowledge. Interesting research years ago by Benoit Mandelbrot, that has been made more popular by Nassim Taleb's book The Black Swan, analyzes the incidence in stock markets (and elsewhere) of very small probability long tail events that give rise to large upward or downward movements in stock prices. By their very nature it is extremely difficult to forecast the timing of these low probability events. This is one reason why even most experts' forecasts of the large movements in stock prices are usually so bad. One can then hardly expect even reasonably rational stock market participants to be able to predict major turning points in stock prices. A "rational" stock market bubble would be a situation where stock prices reflect present earnings and the expected future earnings of the large majority of market participants, and where future earnings are expected to rise over time. Then equilibrium stock prices would also rise over time. These earnings expectations eventually deviate far from the earnings that would be determined by sales, costs, and the like. In this scenario, more or less every participant is acting rationally relative to his expectations, yet the market is not behaving efficiently. Considerable frontier research in finance and macroeconomics is trying to determine whether much credence can be placed in the real world relevance of such rational price bubbles.

Comments

[Jack]

"Perhaps it should have been clear that profits in 2004-07 were too high to be sustainable, but it surely was not apparent to the vast majority of participants."

......... It would be interesting to delve into how and where these high profits were obtained. Graphs indicate "our" productivity increasing sharply over the last decade, but are "we" gaining in productivity or just getting the work done overseas at cheaper labor costs?

"Not sustainable?" Why? Is it that our market is becoming saturated as in autos and housing? I can't claim to have seen "it" coming but have lamented stagnant wages and its stifling effect on US demand since the last bubble.

http://news.bbc.co.uk/2/hi/business/5303590.stm

The chart at the bottom tells the story well. Had wages followed the productivity gains upward US consumers really could have "gone shopping". Since we (and most of the world) is operating at well below full capacity the "shopping" would not have resulted in inflation.

Nothing could have helped us avoid the wholesale corruption of Wall Street and the resulting Mess, but once we've shored up that situation there will still be the problem of stagnant wages, exacerbated by unemployment that in the US means little income for those "covered" and no income for the other half who are not covered. Somehow, and well beyond what is possible in any "stimulus" package median wages have to rise enough that "shopping" can resume.

Another "oil shock" and/or continued bleeding from the soaring costs of H/C taking yet more out of a stagnant wage and high unemployment would mean the US would remain in a nasty recession for a long time.

A Speculation

Could it be that we are at the end of an old order? That today we reached a tipping point where productivity increases and out paces our ability to "go shopping?" That the profits are so ensconced in the super-wealthy "owner class" that labor and therefore the consumers that the welfare of the world is dependent upon has lost their power to obtain wage gains?

If so....... and it seems we've been toying with this through EITC and a host of other transfer payments, it may be that there is no choice but to further increase transfer payments. I'd rather not see that as it would create even more distortions than we have now.

Can it be that those behind the scenes of both the Bush and Obama admins KNOW that the thing won't run without massive deficit spending?

In a science fiction world where goods are mostly provided by robots are the consumers to be enslaved by those "owning" the robots or are they to be empowered by receiving dividends from our technology?

[TDS]

Thank you for this discussion of market efficiency. In his MIT lecture last month, Robert covers how fat tails may be partly explained through the decomposition of debt into cash and a put option. A put option ahead of its maturity will have a more extreme slope the closer the asset value gets to zero. As a result, the writers of such puts (lenders) will present returns that are increasingly sensitive to asset values, the closer those asset values get to zero.

[nolosoft]

Do you know NoloSoft TradeMax? A tax software designed for active investors or traders to manage their trade data maximize their gain/loss strategy, prepare their Schedule D. More details by google "NoloSoft TradeMax" to go to the home page.

Spring Promotion:
Purchase any TradeMax software now will save you 20%.
Just entering Coupn Code: NOLO-BN2S-MAX in the buying page.
This Promotion through 4/15/09.

May be you can have a try.

Hope can help you.

[Street Rat]

A couple of points. One, it is less difficult to outperform DJI if the index still included AIG and Citi...

Second, as Posner alludes to, the "Black Swan" may have been a regular old white swan subsequently painted black by revisionist history. The bubble was perceived by many back in 2006 and its effects could have and should have at least been considerably softened by Greenspan raising rates.

Related to this second point is TBTF and repeal of Glass-Steagall, and the much-discussed non-regulation of bond market synthetic CDO activities, including shorting activities in the form of CDSs. I would submit that the metrics are simply not geared toward seeing an imminent Black Swan event. In order for that to occur, there must be a regulatory, academic, and financial industry approach that takes TBTF/systemic risk seriously.

[runescape gold]

Great site and I am really pleased to see you have what I am actually looking for here and this post is exactly what I am interested in. I shall be pleased to become a regular visitor

[Denis J. Hauptly]

What happens if everyone invests their money in index funds or, to pose a somewhat less absurd question, if half the money isn in index funds? As a smaller group of stock pickers extablishes the market does the advantage of index fubds decrease? At what point does it turn negative?

[Bababooey]

Jack-

while wages fell, non taxable type compensation (primarily the cost of health insurance, but other types as well) rose dramatically. So compensation did indeed rise and it was spent on medical treatment far in excess of what is consumed in the rest of the world. Americans like upgrading their cars & TVS, big houses and expensive often unnecessary medical treatment.

Or so it seems to me.....

[Effiffjep]

Hey guys!

Just wanted to give everyone a heads up!

There has been a lot of hype around the Forex Autopilot Turbo, also know as FAPTurbo program.

At first I was a bit skeptical, but after trying it out, it seems quite profitable. It's a robot that will do
trading automatically for you. I tried it on a demo forex account first and then moved to the live account
and haven't looked back since.

Message me for screenshots if you want!

Their official site is:
FAPTurboLive.net

Regards
Martin Pessener

[Effiffjep]

Hey guys!

Just wanted to give everyone a heads up!

There has been a lot of hype around the Forex Autopilot Turbo, also know as FAPTurbo program.

At first I was a bit skeptical, but after trying it out, it seems quite profitable. It's a robot that will do
trading automatically for you. I tried it on a demo forex account first and then moved to the live account
and haven't looked back since.

Message me for screenshots if you want!

Their official site is:
http://www.FAPTurboLive.net

Regards
Martin Pessener

[MaryFenelry]

Good Evening

I am sure you have all heard about the FAPTurbo Automated Forex Trading Robot (their site is fapturbolive.net)

There has been a lot of hype around it and it claims to make people rich. I personally think it's a scam and would
never purchase it, but there are lots of people who believe in it.

Lot of review claiming that it works...How many of those reviewers have actually tried it? These people are
just trying to make a commission off your purchase. The reviews are fake...

I recently read a report by a beta tester which was actually really an eye opener to me.

You might wanna check it out:
http://www.FAPTurboScam.org

Warm regards

[appadslymnkak]

Good Morning,

Here is my Forex MegaDroid Review, a new automated forex trading robot:
(Official website: forex-megadroid.org)

Review source : forex-megadroid-review.com

OVERVIEW

Are you a forex trading newbie or an established trader that is continuously in search of a profitable forex trading

system? Well the time for you to stop looking has come. The Forex Megadroid is now here to answer your need.

Forex Megadroid is a new forex trading robot resulted from months of research, testing and development. It claims to be

95.80% accurate making it possible for any trader to make a whopping 100% of profits each month.

The use of RCTPA or Reverse Correlated Time and Price Analysis makes the Forex Megadroid unique amongst other forex

robots available in market today. Through this analysis, the Forex Megadroid has the ability to predict the market's

movement in the next 2 to 4 hours thus keeps its traders from losing due to sudden reversal of the market that manual

trading and other forex robots fail to detect.

WHO CAN USE THE FOREX MEGADROID?

Forex Megadroid is the perfect robot for those who wanted to trade forex but do not have enough time like of those who

have a day job, and thus need an intelligent software and minimal human intervention.

Even those who wanted to trade forex but do not have enough knowledge to do it can still trade forex using Forex

Megadroid because it requires no experience to use because of its plug and play concept. All you need is a little

computer knowledge like learning how to download and install the product.

Generally, the Forex Megadriod is for everyone who wants to earn a decent amount of money from forex trading because it

is very fast and easy to use. It even included a pre-configured copy of Meta Trader trading platform in the download area

with an installed Forex Megadroid in it so that you can immediately test the robot on a demo account.

Review source : forex-megadroid-review.com

THE PEOPLE BEHIND FOREX MEGADROID

So, who are the makers of Forex Megadroid? Are they credible enough to convince us from buying their product?

Two experienced forex traders, John Grace and Albert Perrie, made this robot possible. They have a combined in-field

experiences of 38 years making them believable enough why they have created the Forex Megadroid.

Both of them have been into the forex industry particularly in a forex trading rooms for commercial banks. The

experiences they have before leaving their day jobs to develop the Forex Megadroid, made the robot believable enough to

perform extraordinarily.

REASONS TO BUY IT

Everybody wants to earn money. Admit it! You wanted it and I wanted it! In trading forex, we tend to forecast the

market's movements using different indicators that we believed to do the job.

Various forex trading robots are coming out in the market, but all of them does not have the ability to forecast the

market's possible movement in the next 2-4 hours. That is the reason why Forex Megadroid is by far different from them.

Forex Megadroid's use of RCTPA made it able to forecast the market's movement in the next 2-4 hours, which I think is the

most important aspect in forex trading. The Forex Megadroid's use of the RCTPA is a new and exciting technology.

Official website (Buy here): forex-megadroid.org

Regards
Martin

Review source : forex-megadroid-review.com

[–õ—É–∫–∞ –°–µ—Ä–≥–µ–µ–≤–∏—á]

A "rational" stock market bubble would be a situation where stock prices reflect present earnings and the expected future earnings of the large majority of market participants, and where future earnings are expected to rise over time.

[Anonymous]

http://www.orjinallida.info nice blog thans

[Anonymous]

مركز تحميل

[Anonymous]

thanks for your post.perhaps you will like ed hardy

[Anonymous]

mpN3Sc comment2 ,

[Anonymous]

IfojMj comment3 ,

[Anonymous]

Beautiful site!

[Anonymous]

بنت الزلفي

[Anonymous]

If you have to do it, you might as well do it right.

[Anonymous]

Very interesting site. Hope it will always be alive!

[Anonymous]

Great site. Keep doing.

[Anonymous]

I want to say - thank you for this!

[Anonymous]

Great site. Keep doing.

[Anonymous]

It is the coolest site, keep so!