Interview with Professor Random Walk

[MBAustin]

Although his parents named him Burton Malkiel, I always think of him by his book title (A Random Walk Down Wall Street). I read the 4th edition of his book for an MBA class in the '80s, and the 11th edition will come out this year.

Just heard a nice interview with him on NPR

Interview: Burton Malkiel, Author Of 'A Random Walk Down Wall Street' : NPR




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[Onward]

He's one of the Archangels of my FIRE. Amen, Burton. And thank you.

[Spanky]

Another golden advice to buy and hold and stay the course instead of following the experts or timing the markets.

[RonBoyd]

Quote:

Originally Posted by MBAustin and the 11th edition will come out this year.

Is this one of those "And I'll keep doing it until I get it right" kinda thing?

[gcgang]

http://mebfaber.com/2015/01/12/the-m...thash.pH5Cs4GL

Above doesn't seem random. It shows market sentiment, as reflected by Investors Intelligence %Bullish. The 10years following highest readings average 0.1%. The ten lowest average 17% return subsequent year.

Btw, 2014's reading of 76 is 2nd highest on record.


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[CaliforniaMan]

Quote:

Originally Posted by gcgang The Most (Not) Hated Bull Market – Meb Faber Research – Stock Market and Investing Blog Above doesn't seem random. It shows market sentiment, as reflected by Investors Intelligence %Bullish. The 10years following highest readings average 0.1%. The ten lowest average 17% return subsequent year. Btw, 2014's reading of 76 is 2nd highest on record. Sent from my iPad using Early Retirement Forum

Of course that relationship is not random. As a bull market progresses, people become more bullish, during a bear market they become bearish. Some people confuse cause and effect here, thinking that becoming optimistic causes market declines, when in fact it is a result of the previous market increase. Of course when a bear market does occur by definition it must occur after a bull market, hence sentiment will be bullish. In no way does this infer any predictability about the timing of the turn.

[target2019]

I'm surprised by the language in the blog post by Faber. Sentiment is some component of investing and market behavior, but not the cause.

[photoguy]

I don't think Faber is saying that sentiment is the cause but he's implying it's predictive by correlation with the next year's return.

The graph is terrible though. Would have been much better to present as a scatterplot.

[MBAustin]

Quote:

Originally Posted by RonBoyd Is this one of those "And I'll keep doing it until I get it right" kinda thing?

Actually he added a chapter on Behavioral Finance to reflect just what the last few posts mention. People buy stocks when they feel optimistic and sell when they feel pessimistic, which generally results in "buy high, sell low". One more reason to stick with buy & hold.


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[NW-Bound]

I read A Random Walk Down Wall Street in 1999, when I "made" so much money on stocks that I felt something was very wrong and had trouble sleeping. I enjoyed the recall of historical market bubbles from the Tulipmania to the various contemporary real estate bubbles. Sadly, I still harbored a hope that "this time may be different", and hung on to my tech stocks - no dotcoms but hardware and semiconductor stocks - for too long, and gave back all the gains and then some.

Then, came the real estate bubble in 2005-2006, and I did a bit better by trying to apply the lessons learned. I read that Malkiel updated his book to talk about that recent bubble, and meant to read that edition to see what he wrote but kept forgetting.

The mention of investor behavior in a new chapter of the book and also by earlier posters brings up the nagging question that I have always had. That is, if investors or the masses are so dumb, it should be easy to be a contrarian and make money off of their foolishness. Oui?

Of course it is not easy. The problem is to know when the bubble is about to burst. That requires market timing skill. But at least, if one cannot make money he should be able to escape getting butchered if he remembers history. Non?

[pjm-7]

I read the book in the late 1970's and used parts of it for my senior paper to graduate. I was your basic broke college student living in a very tiny efficiency apartment. I used that paper in an interview for my first "financial" job. I landed the job and started my career. I can thank Mr. M for some financial insight as well and the means to get there.

[ejman]

Quote:

Originally Posted by NW-Bound I read A Random Walk Down Wall Street in 1999, when I "made" so much money on stocks that I felt something was very wrong and had trouble sleeping. I enjoyed the recall of historical market bubbles from the Tulipmania to the various contemporary real estate bubbles. Sadly, I still harbored a hope that "this time may be different", and hung on to my tech stocks - no dotcoms but hardware and semiconductor stocks - for too long, and gave back all the gains and then some. Then, came the real estate bubble in 2005-2006, and I did a bit better by trying to apply the lessons learned. I read that Malkiel updated his book to talk about that recent bubble, and meant to read that edition to see what he wrote but kept forgetting. The mention of investor behavior in a new chapter of the book and also by earlier posters brings up the nagging question that I have always had. That is, if investors or the masses are so dumb, it should be easy to be a contrarian and make money off of their foolishness. Oui? Of course it is not easy. The problem is to know when the bubble is about to burst. That requires market timing skill. But at least, if one cannot make money he should be able to escape getting butchered if he remembers history. Non?

I've been able to demonstrate to my entire satisfaction that my market timing skills are worse than zero. That's why I've been very satisfied with the results of rebalancing within very wide bands since I ER'd at the end of 2002.

My results with a nominal 50/50 have been about 8.3% (annualized per Quicken) vs about 10% or so for the Vanguard 500 index fund. Of course it would have been better just to stay with the index 500 for the whole ride but I don't think I would have had the intestinal fortitude to resist doing something stupid during the 2008 shenanigans if I had been 100% in stocks.

[CaliforniaMan]

Quote:

Originally Posted by photoguy I don't think Faber is saying that sentiment is the cause but he's implying it's predictive by correlation with the next year's return. The graph is terrible though. Would have been much better to present as a scatterplot.

I should have phrased my remarks better, there is no causation or predictive value in investor sentiment indexes. Think about it for a moment, if it were that simple everyone would use it and its predictive value would disappear, such is the effect of an efficient market.

[NW-Bound]

We cannot use Efficient Market Hypothesis (EMH) to dismiss ideas offhand because we will not get very far with anything. Let me apply EMH in a case that just comes to mind.

They say doctors make more income than the average Joe, but we know that it cannot be so due to EMH.

If doctors really made more money, then other workers, being desirous of money, would also become doctors. This had the effect of increasing the supply and the surplus of doctors would dilute their earning power. They would end up earning just the average income of the population.

Well, everybody makes the same money anyway, EMH tells you, not just doctors.

Quote:

Originally Posted by gcgang The Most (Not) Hated Bull Market – Meb Faber Research – Stock Market and Investing Blog Above doesn't seem random. It shows market sentiment, as reflected by Investors Intelligence %Bullish. The 10years following highest readings average 0.1%. The ten lowest average 17% return subsequent year. Btw, 2014's reading of 76 is 2nd highest on record.

So, let's look at the data on its own merit.

I look at that link, and the data presented is very interesting.

Hmmm... Right offhand, I do not see a strong correlation between investor sentiment and the slope of the S&P 500 price. But the author presents the following observations.

a) Of the most recent 50 years, he picks the 10 with highest sentiment. The average return of the following years of these 10 was 0.1%.

b) Then, he picks the 10 with lowest sentiment. The average return of the following years was 17.4%.

It appears that in the other 30 years where the sentiment is not at the extreme, it does not make a good indicator. When the sentiment is high, the next year tends to be flat. But when the sentiment is pessimistic, the following year return tends to be above normal.

The author points out that the sentiment in 2014 is the 2nd highest in the past 50 years. So, should I be concerned? Looking at his data, I see that the market has 50% chance of going up or down with high sentiment. This is below par because we know that the overall average return is up.

The last observation agrees with my earlier gut feeling which I posted in a recent poll about expectation for next year return. I anticipated that the market at 2015's end will be within +-5% of its starting value.

In contrast, a poor sentiment appears to be a good "buy" signal. Again by gut feeling, I did make many "buy, buy, buy" posts on this forum in early 2009. When I bragged about it in a recent post, Lsbcal teased me about it, and I said that I only do "buy" signals. It is really trivial. "Sell" signals are a lot harder, and I have to defer to the Oracle of New Orleans and her "Wheee" signal.

I had been thinking about cutting back my 70% stock exposure down to 50% before seeing this data. It's just my gut feeling that the market cannot keep on delivering higher and higher P/E's. On the other hand, it does not have to crash either but may just deliver an average return. I see no reason to get out of the market, but am no longer that bullish. Or I may just stay put as I have a lot of foreign stocks that have not done so well, which I would buy now if I were all in the S&P. Additionally, I think the market will be range bound, and I may look to do a bit more short-term trading, not that the latter will make me much money other than some bragging rights and a hopefully gainful pastime.

PS. I see some interesting things in that investor sentiment data that was not what most people would expect. It shows that if we call it an indicator, it is an erratic one. But then we know everything else also is.

[KeithN]

If only I had the more common sense and been less of a smart ass when younger, I'd be ten times richer

[ERD50]

Quote:

Originally Posted by NW-Bound We cannot use Efficient Market Hypothesis (EMH) to dismiss ideas offhand because we will not get very far with anything. Let me apply EMH in a case that just comes to mind. They say doctors make more income than the average Joe, but we know that it cannot be so due to EMH. If doctors really made more money, then other workers, being desirous of money, would also become doctors. This had the effect of increasing the supply and the surplus of doctors would dilute their earning power. They would end up earning just the average income of the population. Well, everybody makes the same money anyway, EMH tells you, not just doctors. ...

No, no, no, no no. That is not what EMH tells us!

Not everyone can be, or would have the desire/motivation to become a Doctor. There is a limited (maybe somewhat artificial, but no need to go there for now) supply. So demand drives up the 'price'. If there were not the potential high price, some of the people capable of becoming Doctors would pursue more lucrative areas.

And you can turn it around the other way - if a job with far less education paid the same as Doctors, few would bother to invest in an MD degree - this would reduce the supply, and drive up the price of Doctors.

EMH does not tell us that some companies will not do better, and make more profits than others. EMH tells us that to the degree that is recognized, it tends to be reflected in the price of the stock.


Stock price is once removed from earnings. To compare to your Doctor analogy, we would need to frame it like this:

I will allow you to buy 'stock', and receive 5 % of their income in the following people:

A) A Doctor
B) An auto-mechanic.

Now, we both can do a bit of research, and quickly determine that the Doctor will likely have a higher income than an auto-mechanic. So we will be willing to pay a higher price for a 5% share of the Doctor's income than the auto-mechanics. And if we did the math correctly, there won't be a great advantage to one or the other investment.

-ERD50

[NW-Bound]

I was trying to make the point that if investor sentiment is not a good market timing signal, it is not necessarily because of EMH. We should not use EMH to dismiss things out of hand.

If we take EMH as describing how investors react instantly to news, I wholeheartedly agree. But EMH does not mean that people are rational investors. There have been so many bubbles in history to think otherwise.

Back on the use of investor sentiment to predict market movement, even if it were a good signal, and it is not really, not all people would believe it. Why? Greed and fear can cause people to act irrationally. We see that all the time.

[photoguy]

Quote:

Originally Posted by CaliforniaMan I should have phrased my remarks better, there is no causation or predictive value in investor sentiment indexes.

This is something that's testable and we can evaluate with data. Faber linked to data from a third party that is very suggestive that sentiment (at the extremes) may have predictive power for the next year's return. Now from his blog post, there's not much information there about their methodology so it's quite possible this finding is spurious (given it's backtested but not forward tested, and that in general data analysis is easy to mess up) but I don't think I can reject it out of hand.

Quote:

Think about it for a moment, if it were that simple everyone would use it and its predictive value would disappear, such is the effect of an efficient market.

As a counter example, do you think the fact that Shiller PE10 is well known for a long time now has caused it's predictive value to disappear? Does the EMH even imply that PE10 cannot be predictive or can it be explained as extra return due to a risk story?

What if the sentiment index is correlated to PE10 and/or other valuation metrics? In this case it would be predictive but perhaps it doesn't add anything extra.

There have been quite a few papers by academics that try to use sentiment as predictor. I haven't looked at these in any depth but this also suggests the idea may not be totally insane.

Quote:

Originally Posted by NW-Bound We cannot use Efficient Market Hypothesis (EMH) to dismiss ideas offhand because we will not get very far with anything.

I agree -- we have the data so it can be tested like any other factor. I.e. different time periods, different markets/countries, forward tests, etc.

Quote:

I had been thinking about cutting back my 70% stock exposure down to 50% before seeing this data. It's just my gut feeling that the market cannot keep on delivering higher and higher P/E's. On the other hand, it does not have to crash either but may just deliver an average return. I see no reason to get out of the market, but am no longer that bullish. Or I may just stay put as I have a lot of foreign stocks that have not done so well, which I would buy now if I were all in the S&P. Additionally, I think the market will be range bound, and I may look to do a bit more short-term trading, not that the latter will make me much money other than some bragging rights and a hopefully gainful pastime.

How much do you have in foreign equities? I have 40% (of my stocks) allocated to foreign and I'm hoping that their lower valuations (maybe bad sentiment too) will lead to better returns than US in the future.

[NW-Bound]

I have 24% AA in international, and 70% in stock total AA.

That means 34% of my stocks are international, less than your 40% AA.