From The End of Wisdom - a book about why most advice is bullsh*t. This week, the people paid to predict the stock market, and the monkeys who beat them.
Researchers at Cass Business School in London once built an army of monkeys. A computer picked a thousand stocks at random, which is the monkey method, and the exercise was repeated ten million times for every year from 1968 to 2011. A hundred dollars invested in the market-cap index in 1968 grew to about 5,000 dollars by 2011. Half the monkeys did better than 8,700. A third of them cleared 9,100. The dartboard did not merely keep up with the professional consensus about how to weight a portfolio. It beat it.
This is the punchline Burton Malkiel had set up decades earlier in A Random Walk Down Wall Street. Prices move like a drunkard’s walk, and a path determined by chance cannot be predicted, not by chart patterns and not consistently by fundamental analysis either. The more interesting material is his account of why the professionals fail, because only the first of his five reasons is about the world. Random events move markets more than anything a model contains. The other four are about the analysts. They forecast from earnings that companies have dressed up, and Enron misled the profession until the day it collapsed. They misread data with the same overconfidence as their customers. The talented ones get promoted out of analysis and into where the money is. And it is hard to publish a sell rating on a company your own bankers are courting.
At this point everyone raises the same objection: Buffett.
So consider ten thousand forecasters making yearly market calls by flipping coins. After five years roughly three hundred of them have perfect records through pure chance, and after ten a handful look like prophets. The financial industry contains far more than ten thousand participants, and we only ever hear from the winners; the flamed-out thousands do not write bestsellers or give commencement speeches. Study the survivors and luck photographs exactly like skill. The after-stories fit the arithmetic too. Paulson’s legendary subprime trade was followed by years of losses. Dalio’s crisis-proof approach delivered a mediocre decade. Buffett, who is the strongest case anyone has for real skill, trailed the index for years at a stretch and directs ordinary investors into index funds himself, having won his famous ten-year bet that a plain S&P 500 fund would beat a hand-picked portfolio of hedge funds.
None of this proves that skill does not exist. It proves something more useful, which is that from the outside, and usually from the inside as well, skill and survivorship are nearly impossible to tell apart. A handful of glorious records is exactly what a world of mostly failed prediction would produce.
So the lesson is not nihilism. It is pricing. A confident forecast is not information about the future. It is a product, and the confidence is the packaging. The monkeys work for free.
The End of Wisdom: Why most advice is bullsh*t. Paperback and Kindle.