Harvard economist Greg Mankiw has an excellent column in today’s New York Times. I agree with everything in it. So will most economists who read it, but investors rarely listen to us. ‘Expert’ money managers openly despise us. (“Dislike” is too weak a word!)
[W]e economists have written countless studies about the stock market. Here is a summary of what we know:
THE MARKET PROCESSES INFORMATION QUICKLY. One prominent theory of the stock market — the efficient markets hypothesis — explains how answering my mother’s question would be a fool’s errand. If I knew anything good about a company, that news would be incorporated into the stock’s price before I had the chance to act on it. Unless you have extraordinary insight or inside information, you should presume that no stock is a better buy than any other.
This theory gained public attention in 1973 with the publication of “A Random Walk Down Wall Street,” by Burton G. Malkiel, the Princeton economist. He suggested that so-called expert money managers weren’t worth their cost and recommended that investors buy low-cost index funds. Most economists I know follow this advice.
PRICE MOVES ARE OFTEN INEXPLICABLE. ….
HOLDING STOCKS IS A GOOD BET. ….
DIVERSIFICATION IS ESSENTIAL. ….
SMART INVESTORS THINK GLOBALLY. ….
If I could pick just one stock for someone to buy, what would it be? I would now suggest something like the Vanguard Total World Stock exchange-traded fund, which started trading in 2008. In one package, you can get low cost and maximal diversification. It may not be as exciting as trying to pick the next Apple or Google, but you’ll sleep better at night.
N. Gregory Mankiw, “Economic View: What Stock to Buy? Hey, Mom, Don’t Ask Me“, New York Times, 19 May 2013.
Mankiw is applying the term “efficient markets hypothesis” to micro efficiency (inability to predict the future price of individual stocks). Macro efficiency (rational expectations and efficiency of the financial market as a whole) does not follow from micro efficiency. Yes, there are booms and busts in financial markets. If you were able to buy at the trough (when everyone want to sell!) and sell at the peak (when everyone wants to buy!), you would become wealthy. This strategy, as Mankiw explains in this column, is not feasible because of our “ignorance about what moves the market”.