Writing about unknown unknowns would be more interesting, but I don’t know what they are. Instead, I will focus here on some unknowns that have been bothering me. Most have to do more or less with the efficient market hypothesis, whose logic I find compelling and whose exceptions I find confounding.
Most recently, Chairman Bernanke, in his last two post-FOMC press conferences, said what most people in the markets expected him to say and what the logic of the situation called for. Given the still weak economy the present degree of quantitative easing ($85 billion of security purchases per month) would be maintained, but, if the economy strengthens sufficiently, that pace of purchases would be tapered down in the next several months and, when the economy is healthy enough to be on its own, the purchases would be ended. Short-term Interest rates would remain low some time after that. While one of the medicines would be reduced and eventually withdrawn, the economy would be much stronger before it happens.
First, I have a hard time understanding why the markets take that sensible approach so negatively, especially since it’s been articulated so frequently in the past. Second, why does it take two days to move the markets to their new, more appropriate, levels? Actually, it’s four days: two after each press conference. Do the first two days not count because the market subsequently regained some lost ground? And why does the advance after the first two not presage an advance after the subsequent two and thus render it moot?
Efficient markets help explain why active investors have a hard time beating the market and why most usually don’t. Yet, a still-huge financial sector has a vested interest in clinging to the notion that homework and skill can lead to repeatable success, whether they believe it deep in their hearts or not. But, what happened to the rule of buying on the rumor and selling on the news. That makes sense, but day after day we see markets appear to be surprised by the obvious or the telegraphed.
I’ve always been fascinated by the fact that smart, well-educated, well-trained professionals aren’t necessarily better investors than dopes like me who assume that each stock is already priced to reflect all knowns. It does make life easier, however, to assume that others have done your homework for you. It’s like choosing your lane on the freeway. You can maneuver in and out of lanes to enhance your relative position, but as often as not you end up about where you would be if you stayed in the same lane. The others do your lane-switching work for you.
Chairman Bernanke must be tearing his hair out. He offers to help as long as it’s needed and to quit only when it’s not and we respond with sell, sell, sell.