Stock-index Arbitrage Another form of program trading is called “stock-index arbitrage.” A position in a portfolio stocks is combined with an index futures contract with the objective of producing a perfectly hedged position and an abnormally large risk-free return. Arbitrage opportunities arise whenever the value of an index future and the value of the underlying […]
A Digression on Program Trading and Derivative Instruments Whenever the stock market moves sharply one can be sure that financial commentators and even many market professionals will attribute the change to computer “program trading” or to related activities in the futures and options markets. These markets, where one can purchase an option not only on […]
The Market Crash in October 1987 Can an event such as the October 1987 market crash be explained by rational considerations, or does such a rapid and significant change in market valuations prove the dominance of psychological rather than logical factors in understanding the stock market? Behaviorists would say that a one-third drop in market […]
Some Anomalies While it is clear that evidence in favor of the efficiency of markets remains extremely strong, two other studies published in the late 1980s are disturbing because they cast doubt on some of the key assumptions of the efficient-market hypothesis.
Strong Form of the Efficient-Market Hypothesis The strongest form of the efficient-market hypothesis is unlikely to hold. We know that stock splits, dividend increases, and merger announcements can have substantial effects on share prices. Consequently, insiders trading on such information can clearly profit before the announcement is made. While such trading is illegal, the fact […]
Semi-strong Efficiency and Some More Anomalies Academic and financial analysis in the semi-strong school of market efficiency believe that all public information about a company is always reflected in the stock’s price. Thus, they are skeptical about the ability of “fundamental” security analysts to pore over data concerning a company’s earnings and dividends in an […]
Evidence Inconsistent with the Weak Form of the Efficient-Market Hypothesis Recall that the weak form of the efficient-market hypothesis (the random-walk notion) says simply that the technical analysis of past price patterns to predict the future is useless because any information from such as analysis will already have been incorporated in current market prices. If […]
Beyond the Random Walk It is difference of opinion that makes horse races (Mark Twain, Pudd’nhead Wilson). Even a dart-throwing chimpanzee can select a portfolio that performs as well as one carefully selected by the experts. This, in essence, is the practical application of the theory of efficient markets. The theory holds that the market […]
The Middle of the Road: A Personal Viewpoint Let’s first briefly recap the diametrically opposed viewpoints about the functioning of the stock market. The view of most investment managers is that professionals certainly outperform all amateur and casual investors in managing money. Much of the academic community, on the other hand, believes that professionally managed […]
The Semi-strong and Strong Forms of the Random-Walk Theory The academic community had rendered its judgment. Fundamental analysis is not better than technical analysis in enabling investors to capture above average returns. Nevertheless, given its propensity for splitting hairs, the academic community soon fell to quarreling over the precise definition of fundamental information. Some said […]
The Verdict on Market Timing Many professional investors move money from cash to equities or to long-term bonds based on their forecasts of fundamental economic conditions. Indeed, several institutional investors now sell their services as “asset allocators” or “market timers.” The words of John Bogle, chairman of the Vanguard Group of Investment Companies, are closest […]
Can Any Fundamental System Pick Winners? Research has also been done on whether above-average returns can be earned by employing trading systems based on press announcements of new fundamental information. The answer seems to be a clear no.
Do Security Analysts Pick Winners? The Performance of the Mutual Funds I can almost hear the chorus in the background as I write these words. It goes something like this: The real test of the analyst lies in the performance of the stocks he recommends. Maybe Sloppy Louie, the copper analyst, did mess up his […]
Why the Crystal Ball Is Clouded It is always somewhat disturbing to learn that a group of highly trained and well-payed professionals may not be terrible skillful at their calling. Unfortunately, this is hardly unusual. Similar types of findings could be made for most groups of professionals.
The Loss of the Best Analysts to the Sales Desk or to Portfolio Management My fourth argument against the profession of analyst is a paradoxical one: Many of the best security analysts are not paid to analyze securities. They are either very high-powered institutional salesmen or efficient new-business getters, successful in bringing new underwriting business […]
The Basic Incompetence of Many of the Analysts Themselves The overall performance of analysts in many respects reflects the limit of their abilities. Their record with regard to STP Corporation is certainly a good example.
The Creation of Dubious Reported Earnings through “Creative” Accounting Procedures A firm’s income statement may be linked to a bikini – what it reveals is interesting but what it conceals is vital. National Student Marketing, one of the concept stocks, led the beauty parade in this regard. Andrew Tobias described it all in the Funny […]
The Influence of Random Events A company is not an entity unto itself. Many of the most important changes that affect the basic prospects for corporate earnings are essentially random, that’s, unpredictable. Take the utility industry. Presumably it is one of the most stable and dependable groups of companies. During the early 1960s almost every […]
Are Security Analysts Fundamentally Clairvoyant? Forecasting future earning is the security analysts’ raison d’être. As a top Wall Street professional put it in his fraternity magazine, Institutional Investor: “Expectation of future earnings is still the most important single factor affecting stock prices.” Growth in earnings and therefore in the ability to pay dividends is the […]
How Good Is Fundamental Analysis? The Views from Wall Street and Academia How could I have been so mistaken as to have trusted the experts? (John F. Kennedy (after the Bay of Pigs fiasco). In the beginning he was a statistician. He wore a white, starched shirt and threadbare blue suit. He put on his […]
Implications for Investors The past history of stock prices cannot be used to predict the future in any meaningful way. Technical strategies are usually amusing, often comforting, but of no real value. This is the weak form of the random-walk theory, and it is the consistent conclusion of research done at universities such as Chicago, […]