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Here’s What Makes Me Angry
You'll either agree with me or you won't, so here it goes: What reliably makes me lose my cool is when respected professionals passionately embrace an idea, for a while -- only to reject it just as passionately later on.
Fats are bad for you! ... No, fats are good for you -- it's sunshine that's bad! ... Actually, it’s not. Adjustable-rate mortgages are the ONLY way to go! ... Wait a minute...
On that note, let’s talk about some of the financial "gospels." First on the list is the efficient market hypothesis (EMH). For decades, the idea that markets are "efficient" -- that is, every security is always "perfectly" priced, because investors are all rational beings -- has been the cornerstone of modern investment practice. (That and "diversification.") Until 2008, that is, when the current crisis put the spotlight on the EMH’s glaring problems.
Don’t take it from me – take it from Warren Buffett, the world’s most successful and famous investor. Two weeks ago, at the annual Berkshire Hathaway shareholders meeting, Mr. Buffett said that he doesn't believe that market prices are "efficient."
“There is so much that’s false and nutty in modern investing practice and modern investment banking, that if you just reduced the nonsense, that’s a goal you should reasonably hope for. ... There’s this holy writ, the efficient market theory. How do you teach your students everything is priced properly? What do you do for the rest of the hour?”
Thus spake the Sage of Omaha after his company posted its worst performance in 2008.
Now, let's look at another investment adage: In the long run, stocks always beat bonds. Surprise! According to a recent MarketWatch article,
"For the long-term investor, stocks are supposed to add 5% a year over bonds. They don't. ...Starting at any point from 1979 through the end of 2008, an investor in 20-year Treasurys who continually rolled over into the nearest bond and reinvested the income would have come out ahead of the S&P 500."
Any questions?
If you’re as tired as I am of this flip-flopping, I invite you to try a different kind of financial theory. One that states that the markets are not rational, but emotional. One that has proven its usefulness at markets' key turning points for almost 80 years. One whose main proponent, EWI's founder and president Bob Prechter, had this to say about diversification and efficient market hypothesis long before their shortcomings became obvious to the investment public:
"Diversification is gospel today because investment assets of so many kinds have gone up for so long, but the future is another matter. Owning an array of investments is financial suicide during deflation. They all go down, and the logistics of getting out of them can be a nightmare." -- Bob Prechter, Conquer the Crash*, Chapter 18.
"Economists have long tried to cram financial markets into this model, dubbing it the Efficient Market Hypothesis. Even to a casual observer, though, it quite obviously doesn’t fit finance. Prices for stocks do not act like prices for shoes and bread. They race up and down at all degrees of trend and do not consistently reflect any objectively calculated value. Traditional economic theory, then, does not offer a useful model of finance." -- Bob Prechter, April 2004 Elliott Wave Theorist.
The efficient market hypothesis didn’t predict the crisis – Prechter’s Conquer the Crash* did, using the Elliott Wave Principle's social mood model as its main tool. Even more importantly, wave analysis can tell you right now where the markets are likely headed next. Best part? You can try it absolutely risk-free:
*You get a free copy of Conquer the Crash with your risk-free subscription.