Harry Newton's In Search of The Perfect Investment
Technology Investor. Harry Newton
AM EST, Monday, August 10,
2009. How to predict? Do it well and you will be rich
beyond your wildest dreams. Two new books are out:
+ THE MYTH OF
THE RATIONAL MARKET
A History of Risk, Reward, and Delusion on Wall Street by Justin Fox
Warren Buffett, George Soros, Paul Volcker, and the Maelstrom of Markets
by Charles R. Morris
Krugman reviewed them. His piece is worth reading::
Last October, Alan Greenspan who had spent years assuring investors
that all was well with the American financial system declared himself
to be in a state of shocked disbelief. After all, the best and
brightest had assured him our financial system was sound: In recent
decades, a vast risk management and pricing system has evolved, combining
the best insights of mathematicians and finance experts supported by major
advances in computer and communications technology. . . . The whole intellectual
edifice, however, collapsed in the summer of last year.
Myth of the Rational Market brilliantly tells the story of how
that edifice was built and why so few were willing to acknowledge that
it was a house built on sand.
Do we really
need yet another book about the financial crisis? Yes, we do because
this one is different. Instead of focusing on the errors and abuses of the
bankers, Fox, the business and economics columnist for Time magazine, tells
the story of the professors who enabled those abuses under the banner of the
financial theory known as the efficient-market hypothesis. Foxs book
is not an idle exercise in intellectual history, which makes it a must-read
for anyone who wants to understand the mess were in. Wall Street bought
the ideas of the efficient-market theorists, in many cases literally: professors
were lavishly paid to design complex financial strategies. And these strategies
played a crucial role in the catastrophe that has now overtaken the world
to disaster began with a beautiful idea. Until 1952, finance theory, such
as it was, consisted of a set of wise observations and rules of thumb, without
any overarching framework. But in that year Harry Markowitz, a graduate student
at the University of Chicago, gave finance theory a new, hard-edged clarity
by equating the concept of risk previously a vague term for potential
losses with the mathematical concept of variance.
model told investors what they should do, rather than predicting what they
actually do. But by the mid-1960s other theorists had taken the next step,
analyzing financial markets on the assumption that investors actually behaved
the way Markowitzs model said they should. The result was an intellectually
elegant theory of stock prices the so-called Capital Asset Pricing
Model, or CAPM (pronounced cap-em). CAPM is a deeply seductive
theory, and its hard to overemphasize how thoroughly it took over thinking
about finance, not just in business schools but on Wall Street.
eventually share a Nobel in economic science with William Sharpe, who played
a key role in developing CAPM, and Merton Miller, another central figure in
the development of modern financial theory. Long before then, however, the
innovative idea had hardened into a dogma.
One of the great
things about Foxs writing is that he brings to it a real understanding
of the sociology of the academic world. Above all, he gets the way in which
ones career, reputation, even sense of self-worth can end up being defined
by a particular intellectual approach, so that supporters of the approach
start to resemble fervent political activists or members of a cult.
In the case of finance theory, it happened especially fast: by the early 1960s
Miller began a class at the University of Chicagos business school by
drawing a line down the middle of the blackboard. On one side he wrote M&M,
for Modigliani-Miller that is, the new, mathematicized,
CAPM approach to finance. On the other he wrote T for Them,
meaning the old, informal approach.
In this sense,
efficient-market acolytes were like any other academic movement. But unlike,
say, deconstructionist literary theorists, finance professors had an enormous
impact on the business world and, not incidentally, some of them made
a lot of money in the process.
This may seem
strange, since CAPM and the broader work it inspired were based on the assumption
that investors make mathematically optimal investment decisions with the information
at their disposal. As a result, Eugene Fama, of Chicagos business school,
wrote, actual market prices are, on the basis of all available information,
best estimates of intrinsic values. Fama called a market with this virtue
an efficient market and argued that the data showed that
real-world financial markets are, in fact, efficient, or very nearly so. But
if the markets are already getting it right, who needs finance professors?
In fact, however,
Wall Street was eager to hire rocket scientists, especially after
Fischer Black and Myron Scholes, working at M.I.T.s Sloan School, came
up with a formula that seemingly solved the puzzle of how to value options
contracts that give investors the right to buy or sell assets at predetermined
prices. The quintessential collaboration between big money and academic superstars
was the hedge fund Long-Term Capital Management, whose partners included Scholes
and Robert Merton, with whom Scholes shared another finance Nobel. L.T.C.M.
eventually imploded, nearly taking the world economy down with it. But efficient-markets
theory retained its hold on financial thought.
All along, there
were critical voices. Robert Shiller, who has become famous for predicting
both the Internet crash and the housing bust, first made his mark by casting
statistical doubt on the evidence for efficient markets. Lawrence Summers,
now a senior official in the Obama administration, began a paper on financial
markets thus: THERE ARE IDIOTS. Look around. And a whole counter
culture emerged in the form of behavioral finance, which argued
that investors are irrational in predictable ways. But the sheer scope and
sweep of the efficient markets hypothesis not to mention the fact that
so many people devoted their careers to it allowed it to brush off
most of these challenges.
Of course, there
have always been men of affairs wise enough to see past the current dogma.
In The Sages, Charles R. Morris profiles three of them: George
Soros, Warren Buffett and Paul Volcker.
author of The Trillion Dollar Meltdown, doesnt have much
patience with economic theory, and it shows; I almost gave up on the book
after Morris managed, in the space of just a few pages, to thoroughly misrepresent
the ideas of both John Maynard Keynes and Milton Friedman. But the book comes
to life with its personal profiles, especially the surprisingly endearing
portrait of Warren Buffett as a young man.
Do the lives
of the sages carry useful lessons for the rest of us? Soros doesnt really
seem to have a method, except that of being smarter than anyone else. Buffett
does have a method figure out what a company is really worth, and buy
it if you can get it cheap but its not a method that would work
for anyone without his gifts. And Volckers main asset is his implacable
integrity, which most mortals would find hard to match.
Indeed, I came
away from reading these books wondering if their shared under lying premise
that the current crisis will put an end to Panglossian views of financial
markets is right. Fox points out that academic belief in the perfection
of financial markets survived the 1987 stock market crash and the bursting
of the Internet bubble. Why should the reaction to the latest catastrophe
be any different? In fact, what I hear from my finance professor friends is
that theres a lot less soul-searching under way than you might expect.
And Wall Streets appetite for complex strategies that sound clever
and can be sold to credulous investors survived L.T.C.M.s debacle;
why cant it survive this crisis, too?
My guess is
that the myth of the rational market a myth that is beautiful, comforting
and, above all, lucrative isnt going away anytime soon.
Stein gets fired from the New York Times.
Many people weren't big fans. He once wrote a book called "Yes, You
Can Time the Market! and then wrote this:
this on Aug. 13, 2007
the stock market is cheap on a price-earnings
basis, profits are fabulous
and in the long run, both here and abroad,
stocks are a lovely place to be.
More than three
months into the deepest recession in living memory, that as a matter of
definition, we simply cannot be in a recession at all.
He got canned
because he became a shill for FreeScore, another one of those misleading,
rip-off operations that purport to get you your credit score for free.
But read FreeScore's
.. To activate
your trial membership in FreeScore, you will be charged/debited a $1.00 refundable
processing fee and then you can immediately take advantage of the exciting
savings FreeScore has to offer! After your 7-day FREE trial period it's just
$29.95 per month for FreeScore. Remember, you can call FreeScore toll-free
at 1-800-316-8824 within the first 7 days to cancel, and you will not be charged/debited.
Also, remember to ask for a refund of your $1 processing fee. To ensure continuous
service, at the end of your trial period your membership will be automatically
charged/debited each month at the then-current membership fee on or about
that same date to the credit card you provide today or from the checking account
associated with the debit card you provide today. If for any reason you are
dissatisfied, call our toll-free number to cancel, and you'll no longer be
For fun, I called
the toll-free number. It's a machine -- as if I expected anything else.
There is no moral
to this story, except financial writers are people -- occasionally dumb, occasionally
smart. Reader beware.
son bought a new printer for his new business. It's the Brother MFC
It's an all-in-one
laser printer, copier, fax, scanner. He paid $200. CNET thinks the thing is
uninspiring. For CNET's review, click here. But my son loves it because
it does everything perfectly fine -- except print beautiful pictures -- "not
great on pictures." He doesn't care pictures. It's a business machine.
What he does love is that it comes with great software. Setup
was a "breeze" and the drivers and management program don't take over
your computer like the Epson / Cannon / HP software do.
I remember the
good old days when you paid $2500 for just a laser printer.
7 is meant to be a nice operating system. But
getting it onto your computer is a whole other thing -- also called a nightmare.
In contrast, you never have this insanity when upgrading your Apple Mac operating
system to the newest OS You simply load the CD, run it and it works perfectly
on top of your present, older OS. You don't have to copy your files, wipe out
your hard disk, reformat it, load Windows 7 and then re-load all your software
and hardware drivers -- some of which may work, but a lot won't. The contrast
between insane Microsoft and sane Apple is mind-blowing. But then so is the
price of their shares.
P.S. I will not
upgrade to Windows 7 from my present Windows XP. My philosophy is simple, "If
it works, why mess with it?"
are we still there? We went to Afghanistan eight years ago because
Osama was there. He's no longer there. Now we're wasting our precious soldiers
and our scarce resources by fighting an enemy that poses zero threat to the
U.S. -- the Taliban. This morning's Wall
Street Journal (not a left-wing newspaper) carries this story:
U.S. Commander in Afghanistan Warns of Rising Casualties
have gained the upper hand in Afghanistan, the top American commander there
said, forcing the U.S. to change its strategy in the eight-year-old conflict
by increasing the number of troops in heavily populated areas like the volatile
southern city of Kandahar, the insurgency's spiritual home.
McChrystal warned that means U.S. casualties, already running at record
levels, will remain high for months to come. ...
are mounting sophisticated attacks that combine roadside bombs with ambushes
by small teams of heavily armed militants, causing significant numbers of
U.S. fatalities, he said. July was the bloodiest month of the war for
American and British forces, and 12 more American troops have already been
killed in August. ...
The Obama administration
is in the midst of an Afghan buildup that will push U.S. troop levels here
to a record 68,000 by year end. There are roughly an additional 30,000 troops
from North Atlantic Treaty Organization countries and other allies.
war effort in Afghanistan is costing American taxpayers about $4 billion a
It's time to tell
Washington that this War should be stopped NOW. My points:
1. It's been
8 years. That's longer than World War II.
2. It's unwinnable.
But, if we did win, what would we gain? An assured supply of opium and heroin?
3. Though I
don't like them, the Taliban pose us no threat.
4. Our soldiers'
lives are precious. Nothing about this war is worth the life of a single additional
preacher and his son
1. A Bible.
An old country preacher had a teenage son,
and it was getting time the boy should give some thought to choosing a profession.
Like many young men his age, the boy didn't really know what he wanted to do,
and he didn't seem too concerned about it. One day, while the boy was away at
school, his father decided to try an experiment. He went into the boy's room
and placed on his study table four objects:
2. A silver dollar.
3. A bottle of
4. A Playboy magazine.
'I'll just hide
behind the door,' the old preacher said to himself. 'When he comes home from
school today, I'll see which object he picks up.
If it's the Bible,
he's going to be a preacher like me, and what a blessing that would be! If he
picks up the dollar, he's going to be a business man, and that would be okay,
too. But if he picks up the bottle, he's going to be a no-good drunken bum,
and Lord, what a shame that would be. And worst of all if he picks up that magazine
he's going to be a skirt-chasing womanizer.'
The old man waited
anxiously, and soon heard his son's footsteps as he entered the house whistling
and headed for his room. The boy tossed his books on the bed, and as he turned
to leave the room he spotted the objects on the table. With curiosity in his
eye, he walked over to inspect them.
Finally, he picked
up the Bible and placed it under his arm. He picked up the silver dollar and
dropped into his pocket. He uncorked the bottle and took a big drink, while
he admired this month's centerfold.
'Lord have mercy,'
the old preacher disgustedly whispered. 'He's gonna run for Congress.'
is funny, no matter your politics
Barack Obama was out jogging along the parkway one morning when he
tripped, fell over the bridge railing, and landed in the creek below.
Before the Secret
Service guys could get to him, three kids who were fishing pulled him out of
the water. He was so grateful he offered the kids whatever they wanted.
The first kid
said, "I want to go to Disneyland." "No problem," Barack
said, "I'll take you there on my special airplane."
The second kid
said, "I want a new pair of Nike Air Jordan shoes." "I'll get
them for you and even have Michael sign them," Barack said.
The third kid
said, "I want a motorized wheelchair with a built-in TV and stereo headset!"
Barack was a little perplexed by this and said, "But you don't look like
The kid said,
"I will be after my dad finds out I saved your ass from drowning!"
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
is . You can't
click on my email address. You have to re-type it . This protects me from software
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