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Are Markets Rational?
Old 06-15-2009, 03:46 PM   #1
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Are Markets Rational?

A majority of CFAs do not think so:

FT.com / MARKETS / Equities - Crisis of faith for high priests of rational markets


I must think so, I use a lot of index funds and balanced funds. If you do not think the market is rational then how do you deal with the market?
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Old 06-15-2009, 04:02 PM   #2
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I know two CFA charter-holders personally. Both of them have been trying to get me to abandon my index funds and to use active-managed investments recommended by them. Both of them work on the sell-side of investment companies.

I would imagine that most charter-holders do not work for index fund complexes, therefore the poll has to be skewed to show their inherent bias towards their jobs.
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Old 06-15-2009, 04:19 PM   #3
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I like this piece by Larry Swedroe:

Can Market Inefficiencies Be Exploited? - CBS MoneyWatch.com


Even if the market is irrational, few have shown an ability to successfully take advantage of that irrationality...
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Old 06-15-2009, 04:39 PM   #4
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I think Warren Buffett described the markets as manic-depressive. And he is one of the few who seems to be able to take advantage of that bi-polar diagnosis. IANAD.
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Old 06-15-2009, 05:05 PM   #5
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I think Warren Buffett described the markets as manic-depressive. And he is one of the few who seems to be able to take advantage of that bi-polar diagnosis. IANAD.
Sounds about right it was manic during the tech build up and then it went depressive . It was manic in 2007 and then it needed prozac and shock therapy !
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Old 06-15-2009, 05:05 PM   #6
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Animal spirits at work?
http://www.nytimes.com/2009/04/19/bo...hitelle-t.html
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Old 06-15-2009, 05:39 PM   #7
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The markets rational. Shouldn't this be in the joke thread?
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Old 06-15-2009, 05:44 PM   #8
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The Norwegian widow says always adjust your assets so your portfolio SEC yield = 3% at a minimum.

That way you afford football tickets and sit in the stands with your plastic D-fense sign.



heh heh heh - are we supposed to care? .
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Old 06-15-2009, 08:05 PM   #9
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I know two CFA charter-holders personally. Both of them have been trying to get me to abandon my index funds and to use active-managed investments recommended by them. Both of them work on the sell-side of investment companies.

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Old 06-15-2009, 08:13 PM   #10
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The markets are not perfectly rationale nor perfectly efficient.

Example: In 2000 3-Com spun off a minority stake of its Palm division (maker of the Palm Pilot). For a while the market cap of Palm exceeded that of 3-Com, notwithstanding the fact that 3-Com owned the majority of Palm. The market was essentially assigning a negative equity value to 3-Com.

In a perfectly rationale market, arbitrageurs would buy 3-Com and sell short Palm. However, the real world problem with that strategy arises from the dangers of trying to short a hot telecom company in the year 2000. The old adage "the market can stay irrational longer than you can stay solvent" applies. You can be perfectly correct in putting on a trade that exploits the "market's inefficiency" and still end up bankrupt. Congratulations.

So the markets are clearly not perfectly efficient. But that is only important if you can profit from it . . . which study, after study, after study has shown you can not. So who cares?
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Old 06-15-2009, 08:17 PM   #11
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Since the markets are comprised of people (who do the buying and selling) then markets are as rational as the people who create them.

What was the original question? Something to do with rational?
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Old 06-15-2009, 08:49 PM   #12
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The markets are not perfectly rationale nor perfectly efficient.

Example: In 2000 3-Com spun off a minority stake of its Palm division (maker of the Palm Pilot). For a while the market cap of Palm exceeded that of 3-Com, notwithstanding the fact that 3-Com owned the majority of Palm. The market was essentially assigning a negative equity value to 3-Com.

In a perfectly rationale market, arbitrageurs would buy 3-Com and sell short Palm.
I remember that very clearly, owning shares of 3Com myself in 2000. The company said that they would eventually give shares of Palm to 3Com share holders and even announced the ratio of X Palm shares to Y shares of 3Com. But they woud first release a small percentage of Palm to the public as an IPO.

The first day that Palm started to trade as a public company, the market went wild and bid it to a level where it would be cheaper to buy the same shares in 3Com. It means the rest of 3Com has negative value as YTG described.

I checked and checked my arithmetic, then scratched my head asking how the public could be so stupid. Arbitraging by shorting Palm and go long 3Com would be safe, but as Palm just started trading, it would not be so easy as there were not so many shares out there.

The next day, the "market" realized its mistake, and the prices of the 2 stocks returned to a more reasonable ratio.

Yes, it is not easy to make money from market inefficiencies. It is still no excuse for the people who clamored for Palm shares to not understand that ownership of 3-Com shares would eventually get them the spun-off Palm shares a lot cheaper.

I should have taken that as a sign the tech mania was at its peak, and should have gotten completely out. I eventually got out of all tech stocks, but way past their peaks.

"Please God, just one more bubble" - Anon. (seen on a bumper sticker)
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Old 06-15-2009, 09:57 PM   #13
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No one in the business who isn't trying sell something (at least in my limited experience) thinks the markets are rational, any more than we think that investors are rational.
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Old 06-16-2009, 12:14 AM   #14
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You gotta tell 'em, it's people.


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Old 06-16-2009, 06:00 AM   #15
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Old 06-16-2009, 06:18 AM   #16
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I use index funds because the market is inefficient, not in spite of it. The inefficiencies to me are the efficiencies of others-- top management increasing compensation by jacking short-term results, wall street 7- & 8-figure compensations based on creative devices designed to churn financial activity. When or if such events are significantly reduced, the market might become useable by me again. Until then, the best game I have to tag along is judgement-neutral indexing unless I happen to see something I know something about, as was the case with some tech activity 10-15 years ago.

Regarding the belief in efficient markets-- poor people buy lottery tickets. Rich people see simple patterns in immensely complex systems. Humans are very good at deluding themselves. Markets aren't perfect, and evolution isn't either. Restore the brutalities of natural selection and give it a few 100k years and we might get better.
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Old 06-16-2009, 09:30 AM   #17
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I spent half my w*rking life either across the street or in the same building with those kinds of guys, I have to say guys because the gals never broke into those j*bs. It was a kick to ride the elevators with them.
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Old 06-16-2009, 09:50 AM   #18
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That's the way God intended men to live. Unfortunately some of us strayed into other lifestyles.

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Old 06-16-2009, 10:27 AM   #19
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That's the way God intended men to live. Unfortunately some of us strayed into other lifestyles.

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Wrong livelihood? Not all bad, could be the thing that brings some of us to ER.
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Old 06-16-2009, 03:41 PM   #20
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Let's see. Are markets rational?

1.Markets are groups of people with specific common interest.

2. If the markets are rational than the people that form them must be rational.

3. Are people rational?

The only ones that believe people to be rational are economists. Economics is the only field in which two people can get a Nobel Prize for saying the opposite thing.

Besides, anybody that thinks people are rational never met my family, my wife, her family, or any blood relatives on either side.

No, people are not rational. Hence, markets are not rational.
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