Cullen Roche on Market Efficiency

      Ok, I'm on a role today so I might as well go with it. Greg mentioned Cullen Roche on market efficiency. I found this post Cullen wrote:

     "Paul Samuelson always argued that the markets were micro efficient, but not macro efficient. Indeed, the whole concept of market “efficiency” is becoming increasingly irrelevant in a world where entire economies are becoming so highly correlated.  But this doesn’t change the importance of understanding the discussion and its impact."

      http://www.pragcap.com/the-efficiency-of-the-market-doesnt-matter-to-smart-investors

      I got to like a quote from Paul Samuelson. Greg draws the distinction between investing and gambling:

     "The problem too many people have is they think of the market as a place to get rich when it is simply a place to try and keep from getting poor while getting some return better than cash under your mattress. Buffett isn't rich because he traded stocks smartly, he's rich because he bought companies and made them printing presses. It was the real returns generated by the businesses he owned that made him rich, not timing the buying and selling of the stocks."

    "Gamblers try and time their buying and selling, and as Keynes pointed out the smart gambler doesn't pick stocks he likes he tries to guess what everyone else will like and gets them first, but investors build real companies."

   Don't get me wrong-I don't want to disaparage gamblers too much as it can be fun. Cullen's argument that on some level we are all in reality 'stock pickers now' makes sense. Keynes himself didn't get reliable profits from gambling if you will until he became a stock picker. Roche:

  "At the aggregate level we have all become “asset pickers”. The distinction between “active” and “passive” investors is largely irrelevant in a world where we all now pick baskets of assets inside the global aggregate. And when one deviates from global cap weighting (roughly the Global Financial Asset Portfolio) you are engaging in a form of asset picking that makes you no different than a stock picker.  You are declaring that you can generate a better risk adjusted return than the global aggregate.  Indexing has become the new stock picking.  Instead of picking 25 stocks in an index we now pick baskets of index funds inside a global aggregate."

     "The idea of “market efficiency” was never very useful to begin with however because it is constructed around a gigantic political strawman. The EMH is essentially a political construct that argues that discretionary intervention is useless because “the market” is smarter than everyone else. It is a political argument against discretionary intervention that was constructed to create a theory of finance that was consistent with an anti government economic theory (Monetarism primarily). In essence, you can’t “beat the market” because the market is so smart. This is silly though. The market will generate the aggregate market return and your real, real return will be the market return minus the rate of inflation, taxes and fees. Taxes and fees alone will reduce the aggregate return by over 35% (if we assume a 10% aggregate return, 1% fees and 25% tax rate). No one will consistently beat “the market” aside from a few lucky outliers. The math just doesn’t work. And the index we are comparing ourselves to is a completely fictitious benchmark because the average real, real return is lower than the pre-tax and pre-fee benchmark to begin with."

   "But the EMH defenders have misconstrued this entire debate to promote a political position constructed by anti government economists at the Chicago School of Economics. Imagine, for instance, that, for the purpose of record keeping, at the end of each NBA basketball game, the NBA reduced the average score of 100 points by 25 %. And then imagine that the coaches reduced the score by another 10%. What the EMH defenders have done is argued that the score of 100 means that the teams are all terrible because they cannot, on average beat this “benchmark”.  There will be outlier teams who sometimes score more than 100 points, but on average these “professional” teams will underperform.  EMH defenders have used this strawman to argue that “active” investors are all terrible.  It’s a completely useless construct that does nothing more than misconstrue the entire premise of the discussion."