. . . Yrs to Go:
Thanks for your explanation; it’s very helpful. But I see Mauldin differently. Your second paragraph has a couple issues packed in that bother me slightly. First of all, I don’t see Mauldin as just someone who just advocates active investment management, just as Warren Buffet is not any old active portfolio manager. He looks into markets and sees things that are important for investors to know, and I think he does it better than most. You gathered him up in a bag with all the other active managers and implied they are all bag-ettes
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Secondly, I think you belittled his macro-allocation insight. You said “it is the prevalence of indexing (both overt and covert) that causes the market's inefficiency” and then swept that away too. His argument, as I read it, is that indexing takes on a life of its own, becoming a positive feedback loop for even more indexing that works until it doesn’t, until the money starts to flow out and fewer people like it, in one possible instance. This is an important event that explains a part of the reason why index funds and the stocks that underlie them behave the way they do.
I’d like to step away and examine another market sector or actually non-market sector that behaves somewhat similarly to how the indexing ‘positive feedback loop’ works. This could shed some light on indexing, which is on a separate (but related), longer-term cycle
I see the current house price market as containing a mixture of both efficiencies and inefficiencies. The inefficiencies are basically macro in nature: housing prices are just too high all over the place. They are especially high in some areas of the country such as on the west and east coasts. In the mid-west and some pocket areas they are less over priced. I hope most people here would agree with me about that.
One could say that the current housing market is having a macro misallocation problem. Housing is too expensive in general and mostly in the particular too. We can give many good reasons for this misallocation problem that has occurred over the past few years—for argument’s sake—the long run. Everybody here has seen and/or discussed them many times.
We’ve also discussed the micro problem: “Boy, those dang houses are expensive right now.” In most cases each individual that buys a house in our current market is operating efficiently: He or she looks at houses, finds one they like, and negotiates a price that makes them at least reasonably satisfied. They look at comparables that say whether or not the particular house they like is of fair market value. They talk to the bank about how much they can borrow and then spend on a house. They determine if their wages or whatever can support the payments. Then they may start the thinking process of whether it is worth it. Sometimes they have a lot of profit in their current house, which not only says to them that buying a big McMansion has been good in the past it is probably good in the future. Lots of money to be made and nice living in housing. The individual buyer (and the seller) is operating efficiently in the housing marketplace, buying at the best possible price at the time—or so it appears--at that time. Pretty soon, people are just buying real estate on the momentum—a positive feedback loop starts and takes on a life of its own—until it doesn’t.
I, personally, see a great deal of inefficiency in each individual act of buying and selling by ‘rational’ people. This can be examined too: old fashioned value investors in homes will have a tendency to back off from buying at these times—or they sell making them active participants too; growth investors may jump in hog wild, buying more home than they need in anticipation of early retirement or some such other event. This has happened before in other types of markets. So, my question becomes: Can a long (three years?) accumulation of inefficient—yet apparently rational--individual behaviors give rise to an efficient market overall? One doesn’t need more than 50% of people, or some such other quantifiable event, to own or be buying such products to move the market in a particular direction either.
I think the same insight Mauldin offers in his article can be applied to many so-called efficient markets. But each must be applied carefully to particular circumstances to find out if this is true.
What Mauldin offers, although not in detail in a four page article he borrowed, is far more than what you suggest--to my mind. He offers a valuable tool in evaluating financial markets in general, although I am extending this idea further than he might. You said “his argument is essentially no different than that of anyone else who advocates active investment management.” I think you have painted him with too broad of a brush. He has gone into a fair amount of detail about how this macro-misallocation works in the stock market. Having such details and working out specific applications for individual usage, gives one a fair amount of power in determining where, when, and how to allocate ones resources—and how to see the world a little differently. I think you summarized incorrectly, IMO
And, of course, if the housing bubble never breaks but continues to expand then I’m wrong. Or right, but my timing model doesn’t work.
