Burton Malkiel wrote “A Random Walk down Wall Street” in 1973. He believed the prices of publicly traded assets reflected all publicly available information. John Bogle, influenced by Malkiel, created index funds to reduce the risks of random market fluctuations and to profit from this rational pricing.
Peter Lynch wrote “One up on wall street” in 1989. He didn’t agree with Malkiel; he felt that “local knowledge” and personal experience could detect under and overpriced shares.
I suspect each was more or less right for his era. That is, I suspect share prices in the mid to late 1960s were more or less rationally priced. I suspect share prices in the late 1970s and early 1980s were not rationally priced, and that the anomalies were potentially discoverable by a rational investor with limited resources.
Of course by the time each person wrote their book, their era had passed.
Which brings me to our current era.
Since Lynch’s book we have experienced 20 years of economic turbulence fundamentally driven, I suspect, by the commercialization of the microprocessor and the industrialization of what we once knew as the third world. As a side-effect of these fundamental changes, including the collapse of the fourth estate, we have shifted towards the upper end of the historic scale of corporate and governmental corruption.
So what is the rational small investor strategy of today?
Of course I don’t know. My only personal insight is that I don’t yet see much short term correlation between share prices and the value of most of the goods and services I buy. Companies that deliver lousy value seem to track with their industry. The exceptions are a few companies that are intensely monitored (Apple, Google, Microsoft, etc); I think they are rationally priced but they are, of course, very volatile.
This would suggest we’re still in a Lynch era, where one should be able to use local knowledge to detect anomalies and profit from them. Over the past 10 years though you couldn’t detect the anomalies using the “local knowledge” he described – you had to be an insider who was able to sniff out fraud and corruption. In the past decade some have done very well detecting evidence of corruption and de facto fraud, and shorting companies like Lehman.
Of course by the time people like me decide shorting corrupt corporations is a good strategy, its time has passed.
I where are we today? I’m guessing that we’re in transition back to a Malkiel era. So for a few years shorting corruption might still work, but increasingly share prices will be a random walk. Even if index funds were a crummy investment over the past decade (everything was, except shorting fraud), this might be their time again. I wouldn’t mind some 1960s style dull dividend paying companies though.
Of course by the time anyone writes the “Random walk” or “One up” book of our era, that strategy will have passed into history.
Oh, and if you take investment advice from me, you totally deserve your impending financial ruin.
