Rodney Johnson | Friday, October 18, 2013 >>

On Monday, the Royal Swedish Academy of Sciences awarded Professors Fama and Hansen of the University of Chicago, and Professor Shiller of Yale University, the Nobel Prize for Economic Sciences.

Let’s start with the first two recipients of the award this year…

Fama’s contribution to the world was to tell us that we can’t beat the markets because they immediately incorporate all known information. In other words, the efficient markets theory.

Hansen developed methods of testing asset prices.

Now I’m certain that this news was well received in many corners of the investment world, including the Vanguard headquarters, a company that built an empire out of index investing.

After all, Fama’s efficient markets theory allows people to wash their hands of any responsibility for their investment decisions since they can’t beat the markets anyway. Instead, just buy an index fund and then hope and pray it goes in the right direction.

Hmmm.

What happens if the index funds are falling when you need the money?

Oh, that’s right. You just adjust your time frame. I remember now.

I’m sure the news was met with a different sort of reaction from other corners of the investment world…

[WI-Gold-$750-Banner-Collapse-of-Gold]

Like in the basement of the New York Stock Exchange, where high-frequency trading companies place their computers within spitting distance of the exchange’s computers.

This physical arrangement allows the trading firms to see information milliseconds ahead of everyone else, place trades accordingly, and earn profits from it.

Yes, that sounds very, very efficient.

I imagine these guys were giggling in their Fruit Loops about the Nobel Prize this year.

Then there’s the third winner: Yale’s Professor Shiller.

He made a name for himself by warning of the housing collapse… and the tech stocks collapse. He pointed out asset bubbles and the mania that can extend from the psychology of investing when prices continue to grow.

So, two of this year’s Nobel Prize winners say resistance is futile (a Star Trek reference), and the third one claims that bubbles happen.

While these gentlemen create a lot of good analysis, I’m still searching for the piece that moves us farther along.

To say that people won’t do any better by making active decisions in the markets, and that bubbles occur, seems to be at odds. If everything is known immediately, then how can bubbles happen? If bubbles occur, then aren’t we better served by stepping aside ahead of time, or at least having a strategy for exiting when things go south?

How about a Nobel Prize for recognizing that government entities that work hard to ensure profits for the banks by keeping the yield curve steep, greatly influence the markets while harming the rest of us?

How about a Nobel Prize for pointing out that owning an index fund is great as long as you want to be guaranteed average returns and 100% of the risk?

What about the notion that buying non-correlated equities (things that don’t usually move together) is a wonderful idea on a normal day, but when fear sets in all equities move in the same direction… down! I’d support a Nobel Prize for that piece of work.

Obviously I’m not a fan of the efficient markets theory. I’ve seen – and written about – too many instances where the efficiencies are either non-existent or are systematically removed from the marketplace.

What else do you call it when the Fed holds a secret meeting and demands all participants take bailout money SPECIFICALLY so that investors can’t determine who is bust and who is not?

The “efficient market” was on display when Bank of America and Citi were teetering on the edge of failure. Then they were whisked into the arms of the government with tens of billions in bailout money.

And which sector of equities, exactly, held up during the crisis?

What happened to all of those wonderful models that showed crisscrossing lines, cancelling out each other’s risk while earning average returns?

I remember now…

They all took a nosedive.

So did every piece of fixed income, except U.S. Treasurys.

I know I’m mixing efficient markets, irrational exuberance, and Modern Portfolio Theory into the same pot.

But I think investors have been sold a framework that doesn’t work very well for them. Instead, it provides an awful lot of benefit to the purveyors of the “sell” side.

“Buy what we have,” they say.

“There are no advantages,” they tell us.

…except for the ones they provide to each other or sell to the highest bidder.

Rodney

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Rodney Johnson
Rodney works closely with Harry to study the purchasing power of people as they move through predictable stages of life, how that purchasing power drives our economy and how readers can use this information to invest successfully in the markets. Each month Rodney Johnson works with Harry Dent to uncover the next profitable investment based on demographic and cyclical trends in their flagship newsletter Boom & Bust. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. Along with Boom & Bust, Rodney is also the executive editor of our new service, Fortune Hunter and our Dent Cornerstone Portfolio.