Investing Myths Debunked

In the last section, we discussed some of the disingenuousness that surrounds
discussions on the ever-upward trend of the market, and therefore
of individual stocks within it. Now we touch on a few other gripes that we
have with much of the advice often proffered by investment experts’ writings.

There is certainly plenty of advice out there for the Average Joe who
is looking for the best way to use his savings in order to make money from

investing. With all of the many and varied “how-to” books, each containing
its own sometimes bewildering, often contradictory advice on investing
and trading styles and systems; it is no wonder that most readers either
throw their hands up in horror or end up more confused after reading them
than before they opened up the cover. Despite the intention of each writer
to contribute something new to the genre, interestingly, there are a number
of common themes within investment literature that are written about
ad nauseam. On closer inspection, these themes seem to provide unnecessary
complication or even misinformation and propagation of myth to the
investing advice mix.

Many investment writers stress timing. For some reason, many of them
suffer from a strange obsession with market tops and bottoms, particularly
the beginnings and ends of bull and bear markets. As will be seen from
last article, this is an obsession that appears to have its foundation in Dow
Theory, an investing strategy with a long pedigree that has influenced the
thought and actions of investors and traders alike for over a century, and is
the forerunner of technical analysis. It has to be understood, however, that
bull and bear markets represent shifts in sentiment that happen only every
few years or so. The length of time that the entire bull/bear cycle runs may
take many years, possibly up to a decade or more. Yet such writers whose
focus is on spotting these tops and bottoms will happily expend an acre or
so of the Amazon rainforest explaining how to recognize the signs that a
market bottom or top has been reached. There were dozens of books published
just in the past two decades alone, and a handful published as far
back as the 1960s, on market timing. Many of them simply review different
theories about how markets are timed and invite the reader to choose his
or her favored approach as, for example, the introductory work, Complete
Idiot’s Guide to Market Timing. Others, however, believe they discovered
the market timing philosopher’s stone and try to instruct their readers in
how to time the market’s up and down cycles. The scenario is usually as
follows. When the point has finally been reached where the market has
reached a bottom, they instruct the investor to make an insightful purchase
at precisely the “right” price level. Then, these writers advise that
the intrepid investor must scrutinize closely for similarly clear signs that a
market top has been reached. Again, the investor must time everything just
right, thus achieving the goal of cashing out at precisely the moment when
investment earnings are maximized.

It is a feat of almost impossible brilliance for anyone to succeed in
spotting exactly when the market has hit the bottom or top. Unfortunately,
neither the professional nor the lay investor has a crystal ball to tell
when the market is at its high or low. Neither does a bell ring at that
point. Moreover, what is an investor to do if he missed the opportunity
provided by a market low? Does he now wait several years or decades until

the market again reaches a secular low and presents him with another
appropriate buy signal?

Even when market pundits are not trying to accomplish something as
ambitious as identifying a market top or bottom, many do claim that they
are able to spot an individual stock’s top or bottom. This is where the technical
analysts enter into the picture with their various charts and symbols
like dogi stars, shaven heads, hammers, and hanging men. They attempt
to interpret all kinds of bizarrely named patterns that can be read from
charts illustrating past stock movements in an attempt to predict what their
next directional move will be. Here is an excerpt from Toni Turner’s A
Beginner’s Guide to Day Trading Online: “If the next candlestick after
the Evening Dogi Star is a white real body, the Dogi warning is negated.”
Hmmm.

There most certainly is no shortage out there of those who claim
that they have all the answers. Even when they are not promising to
teach others how to interpret the signs, there are those who promise
that they can provide the tools necessary to achieve success. (California
Gold Rush syndrome again perhaps?) There are dozens of Web sites that
lure the investor/trader with promises that their fortunetelling market
experts can signal the precise moment when the investor should buy
or sell stocks, mutual funds, or bonds if the investor is unable to do it
himself. Some promise that they can pinpoint and help the investor avoid
any approaching market crashes. It must be noted that all these sites
charge subscription fees of varying fatness. We have also noted a revival
in investing seminars, advertised through infomercials on late night TV,
that promise to provide insights and tools for successful stock trading
and indicating that those who sign up can be on the road to “financial
independence.” The latter is typically illustrated in the infomercials by a
big house and pool in a sunbelt setting, a big car and lots of time to play
golf or for other leisure time activities. The implication is clear. “Financial
independence” means getting rich without having to work.
Read More : Investing Myths Debunked

Buffettology or Mythology?

People with an ax to grind may be dubious of Buffett’s accomplishments,
and one ax they typically are seeking to have ground is their
adherence to the Efficient Market Hypothesis, the notion that stocks
are always reasonably priced because all information about all companies
is immediately dispersed to the general populace, and the
general populace is composed of equally intelligent, rational individuals.
One person who harbors doubts about Buffett’s abilities is

Larry E. Swedroe, an advocate of index funds and the author of
What Wall Street Doesn’t Want You to Know (New York: St. Martin’s
Press, 2001).

He professes himself to be an “agnostic” regarding Buffett.
Certainly Buffett’s long-term record is impressive, Swedroe admits,
and it may have three causes:
1. He may be a genius.
2. He may have been just lucky.
3. He may have benefited specially from his being an active participant
in companies he buys into, such as Coca-Cola and
Gillette. “He often takes an influential management role, including
a seat on the board of directors, in a company in which he
invests.” So it may be his contribution to the companies in
which he invests that explains his record.
(One might add: Another explanation someone might advance is
that Berkshire has used the float from its insurance company premiums
to compound its returns—at little or no cost. This, observes analyst
Braverman, is akin to Buffett’s having used leverage, or
borrowing money.)

Swedroe continues: From 1990 to February 29, 2000, Berkshire
gained 407 percent. But that was only 0.2 percent per year
more than the S&P 500. Swedroe then does some data mining,
and, he admits, searches specifically for periods of time when
Berkshire Hathaway under-performed. From June 19, 1998, its alltime
high, to February 29, 2000, Berkshire fell 46 percent. The S&P
500 rose 24 percent, not including dividends. From 1996 through
1999, Berkshire rose by 75 percent. But the S&P 500 climbed by
155 percent.

The lesson from Buffett’s record, Swedroe concludes, is that
“choosing active managers, even perhaps the greatest one of all, is
no guarantee of better results.” Whereas diversifying among index
funds, he argues, is.

The obvious answer to Swedroe is that the 1990s were a great time
for the S&P 500 Index because technology stocks ruled the roost, especially
in the last few years of the decade, and the S&P 500 was
dominated by its tech stocks. For Berkshire to have beaten the index
by even a small amount over that period of time is impressive, considering
Buffett’s aversion to technology stocks. And the fact that
Berkshire endured some mediocre years and some poor years is not
surprising; the S&P 500 has suffered dry spells as well. In any case,
value stocks are notorious for trailing behind the general market

during long time periods, which might explain why value investors
wind up being so generously rewarded.
Read More : Buffettology or Mythology?

MYTHOLOGY OF EARLY LAISSEZ FAIRE

If laissez faire has performed so poorly and constitutes such a threat, why are
we so enthralled by it? For we have not always been captivated by this
philosophy. It was not that long ago, during Franklin Roosevelt’s presidency,
that we abandoned laissez faire in favor of Keynesian interventionism. We did this
not because of ideology but because laissez faire had failed so miserably.

According to free market orthodoxy, Roosevelt’s abandonment of the
ultimate economic truth had to be a mistake. Yet this period, characterized by
aggressive government intervention, was marked by an economic resurgence.
Also contrary to free market orthodoxy, as we have moved back toward a purer
free market, our economic growth and productivity growth have slowed.
Why did we return so eagerly to a philosophy we had rejected because it
had failed? Why have we persisted with it despite its failure?

One reason for our revival of laissez faire stems from our confrontation with
global communism and our attempt to prove, to ourselves as well as others, the
superiority of our economic system. The success of our struggle, the spontaneous
collapse of the U.S.S.R., was widely advertised as proof of the invincibility of the
free market.

Given the invincibility of laissez faire and also the perception that it has been
the economic system of Western countries since the Industrial Revolution, it
was but a short step to argue that free market policies have been the ultimate

source of our progress of the past two centuries. (This makes for good
mythology, but it is not borne out by the facts.)

Independently, the superiority claimed for laissez faire dovetails with
personal interests. The taxes collected by government hit close to home. We can
easily figure out how much more disposable income we would have if we didn’t
have to pay taxes. By contrast, the benefits provided by government are often
indirect and we cannot measure how much they affect us. It is too easy to argue
that we are net losers, we don’t get fair share for our taxes, and we would be
better off without government.

Professional economists have their own incentive to support laissez faire.
Most work for large financial corporations. These corporations employ
economists to increase their profitability. A laissez faire environment, free of
government regulation, is conducive to maximizing profits. So it is to be
expected that most economists should argue for laissez faire.

Finally, the mathematics of pure free markets is simpler than the
mathematics of complex systems of constraints. Reflecting this, academicians
tend to pursue models based on pure laissez faire. Economics departments at top
universities have become pulpits for preachers of laissez faire and breeders of free
market disciples.

There is a stale joke about the University of Chicago, one of the bestknown
disseminators of free market orthodoxy.
Q: How many University of Chicago economists does it take to change a
light bulb?
A: None. They all sit in the dark and wait for an invisible hand to change it.
Whether or not this provides a fair caricature of the Chicago School, it is
only reasonable to consider a rejoinder by the laissez faire economist: “It may be
frustrating to sit in the dark. But if you talk to people who have tried to change
the bulb, there is a consistent pattern. They have caused a short circuit and then
called the electrician. Not only has he charged an arm and a leg, but in the
process of fixing the short circuit he has broken the main water line. The
plumber, in fixing the water line, has left huge holes in the walls. The mason, in
repairing the walls, has shorted the electrical system. Sitting in the dark may be
inconvenient, but trying to fix things only makes them worse. Waiting for the
invisible hand of the free market to fix economic problems may be frustrating,
but government interference is worse.”

Such a response has become an article of faith for many who have forgotten
the Great Depression and the utter impotence of free market policies to

stimulate growth or employment. By the time Franklin D. Roosevelt took office,
real GNP had declined 30%. Industrial production had fallen more than 50%.
Iron and steel output had dropped nearly 80%. Investment had plummeted 95%.
Measured unemployment had risen past 20%. And there was no sign of
imminent stabilization, much less improvement.

Our faith in the beneficence of the pure free market has not been examined,
nor would it stand up to scrutiny. Rather, it has gained popularity as
government has grown, as the arrogance, unresponsiveness and sheer stupidity
of government agencies have spawned frustration and bitterness, and as shrewd
politicians have exploited this alienation. As a result of often justified emotions,
many long to return to the days when government was smaller and private
enterprise was able to be both private and enterprising. Since the 1980s America
has been gripped by nostalgia for small government and “true” free market
economics.

There may be reason to address this nostalgia in historic, as well as
economic, terms. Especially in periods of change and uncertainty it is common
for individuals to romanticize and long to return to the good old days — no
matter how bad they were.

There are still those who yearn for the days of mediaeval chivalry, for the
rustic simplicity and closeness to nature of peasant farmers. No wonder many in
today’s society want to see a return to the good old days of unconstrained
capitalism, with government off the backs of entrepreneurs so free enterprise
can “do its thing.”

The problem with this longing for the past is that it has always been
selective to the point of blindness. Mediaeval chivalry may have been tolerable
for the extreme upper crust. The rest were reduced to lives of animals, lives
blighted by chronic malnutrition and punctured by disasters, both natural
(recurrent famine, the Black Death and a host of epidemics) and man-made
(large and small wars, banditry and civil unrest).


Ignoring history, we romanticize this period just as we idealize the life of
the cowboy, not realistically portrayed in Hollywood movies.
With respect to our vision of the good old days, when free market
enterprise was able to “do its thing,” it is necessary to retain a critical faculty and
avoid romanticizing, lest we be seduced by popular mythology. For one thing,
there were no such days. In our enterprising colonial days government had the
power to fund public projects, regulate prices and wages, set standards, and
grant monopolies. Nor did the American Revolution diminish government
power. It was New York State, not private industry, that underwrote the Erie
Canal. It was Alexander Hamilton who enunciated our first industrial policy.

Jefferson, too, supported the public construction of roads and canals and
government subdivision of new lands for small tenant farmers.
Even the good old days of the Industrial Revolution fall short of the
imaginations of free marketers seeking our lost paradise. For one thing, the
picture of capitalism driven by small entrepreneurs and inventors vigorously
competing against each other on a flat playing field is badly distorted. It is more
fiction than exaggeration. “[E]ighteenth-century manufacturers only launched
their large-scale enterprises with subsidies, interest-free loans, and previously
guaranteed monopolies. They were not really entrepreneurs at all...” (Braudel,
The Wheels of Commerce, p. 193)

In addition, the golden age of capitalism was hardly a boon to most people.
The Industrial Revolution achieved a dramatic acceleration of measurable
economic growth, and the political system, having disenfranchised the lower
and middle classes, posed little threat to the autonomy — and tyranny — of the
free market. Despite such an ideal laissez faire environment, historians note the
terrible poverty as well as the environmental degradation. Great novelists of that
era, Dickens and Zola, took pains to depict the squalor and the breadth and
depth of suffering.
Read More :MYTHOLOGY OF EARLY LAISSEZ FAIRE