Of course, this time could be different! Maybe the STS approach won't work anymore. Remember, you can never prove a hypothesis; you can only disprove it. And maybe you don't want to wait 5...10...or 20 years for the P/E ratio to fall under 10 so you can get into the stock market, anyway. Everything has a price. And the price you pay for the safety and performance of STS is time.
But today, we want to take up the subject from a slightly different direction. We want to explain a hypothesis of our own view.
First, as you could see from our discussion of EMH and its critics, the matter was far from decided. On the one hand, EMH says investors are rational, profit seeking people who will use all the known facts and opinions to set the right prices. The other says they will consistently err. But the other side also says that while some investors are smart enough to take advantage of other investors' errors, they are not smart enough to eliminate them. There's the rub. Why not?
Both sides believe that stocks have a 'correct' price. EMH advocates believe the correct price is set by the market. EMH critics believe the market frequently errs, and that its mistakes are observable, calculable and correctable (or arbitrageable). The critics do not explain how come - assuming you can see them and bet against them - the 'innovations' persist. Seeing a stock underpriced by the mob should bring forth buying on the part of the smart money, thus bringing the price immediately back into line with expected earnings. Porter attempted to explain this inconsistency by saying errors persisted only in 'inefficient' markets and so forth. But if there were money to be made, you'd think an ignored market would attract interest and become much more efficient, fast. He also said that 'conflicts of interest' prevented the big players from betting against certain anomalies. But that assumes all the big players are on the same team. They are not. Our experience of Wall Street tells us that the big firms are very cannibalistic. Given a choice, they would prefer to feast on the carcass of one of their own species than on the flesh of small investors.
It is more likely that the 'errors' persist, because they are not as visible and redressable as the critics maintain. They are errors of judgment - and thus subject to a substantial amount of error themselves - not errors of calculation.
In short, our hypothesis is this:
Our hypothesis comes from the recognition of the asymmetry of knowledge. We can never know what a stock is worth. All we can do is guess. It stands to reason, that people who do their homework take better guesses.
But there are no 'correct' answers. The market discovers new prices every second...based on all the inputs to which humankind is receptive. Those include a rational calculation of the present value of a stock's expected future earnings, discounted for risk. Also included are opinions, guesses, rumors, myths, and all manner of prejudicial half-truths - some firmly founded on logical thought and observation, others more delusional and whimsical.
There are no 'innovations.' Because there is no correct answer to innovate against.
The market merely aggregates opinions - right, wrong, stupid, baffling - and discovers a consensus. Usually, those who do the hard work of valuing an income stream make better predictions about tomorrow's consensus prices. But not always.
In our view, a market - and life itself - is only somewhat subject to rational calculation. Sometimes, doing the numbers works. Sometimes, yesterday's numbers give no hint of things that will happen tomorrow.
There's more to the story...something else going on. Something that often defies your logic...and throws your hard work in your face. Just what kind of thing are we dealing with? You'll find out tomorrow, when this series concludes.
Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.