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I think you are correct that the punters often think they have "unique insight" into the markets, and therefor place bets on that.  but the reality is that this information is almost certainly already known, and discounted into stock prices.  this forms the fundamental assumption of the "random walk" theory of the stock market, which has been verified many times over the years.

mutual funds on average perform worse than the overall market, mainly because they have to deduct their fees from the returns.  thus even producing "market returns" means you are actually lower than the market return by the fee--likely 1-3% per year.

I disagree with the last point of course and have explained more than once the rationale.  while there is certainly day to day speculation, the vast majority of trading in the public markets is long term investing, and I've given obvious examples of this in the past.

by wchurchill on Mon Mar 26th, 2007 at 04:44:39 PM EST
[ Parent ]
this forms the fundamental assumption of the "random walk" theory of the stock market, which has been verified many times over the years.

To a certain (high) degree of approximation. The very existence of hedge funds disproves (by countereaxmple) the assumption that information has already been discounted in the stock prices.

I was going to pick a nit on the term "random walk" but I'll refrain. If you're using it in a nontechnical sense there's no nit to pick.

"It's the statue, man, The Statue."

by Migeru (migeru at eurotrib dot com) on Mon Mar 26th, 2007 at 05:25:18 PM EST
[ Parent ]
the random walk theory addresses itself to public markets with a great deal of regulation and transparency, as well as legal controls.  basically the US markets.  my own hunch is that the hedge funds are not doing particularly well in these markets.  however there are other less controlled markets around the world where insider knowledge can be strongly leveraged.  and there are arbitrage situations such as the carry trade, and particularly as it relates to Japan, where I think they can clean up.  Cramer's comments would indicate that he can at least influence quarter ending numbers, for scorecarding purposes, in the American markets.  he also seems to say he can play the American markets, and I admit that challenges what I just said.  But I would love to see analysis of their returns to see where they are really coming from.
by wchurchill on Tue Mar 27th, 2007 at 04:33:41 AM EST
[ Parent ]
so hedge funds can find arbitrage opportunities and exploit them if they move quickly.  And then there are the guys that trade after the close.....
by HiD on Tue Mar 27th, 2007 at 04:47:08 AM EST
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The point is that new information takes time to make it to all the market participants and they take time to react to it, so the "market consensus" takes some time to adjust to the new information. The idea that the market price discounts all the existing information is laughable on its face. Of course, if you're the slowest investor in the pack, you can probably assume that's true.

wc himself seems to spend a lot of effort looking at the fundamentals and investing according to his best assessment of the "available information", which means he doesn't really believe all information has been discounted, or the two-fund theorem.

"It's the statue, man, The Statue."

by Migeru (migeru at eurotrib dot com) on Tue Mar 27th, 2007 at 04:54:15 AM EST
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bingo

And even if everyone had the same info, they don't all draw the same conclusions.  "everyone knew" that the dollar/euro at $1.35 was just a stopping point on the way to the gutter.  Then it traded back in for 2 years.    

by HiD on Tue Mar 27th, 2007 at 05:17:17 AM EST
[ Parent ]
And even if they all draw the same conclusions not everyone has the same risk aversion, the same return requirements, the same access to credit, or the same depth of pockets.

"It's the statue, man, The Statue."
by Migeru (migeru at eurotrib dot com) on Tue Mar 27th, 2007 at 05:28:27 AM EST
[ Parent ]
credit hasn't been an issue lately.  the guys with reputations can raise a billion or 2 before lunch.  It's scary how much money is slushing around.
by HiD on Tue Mar 27th, 2007 at 05:39:31 AM EST
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Okay, so you can raise a billion in 3 hours. How much money can all the other fast players put through without tapping into their credit in those 3 hours?

And also, not everyone is a "guy with reputation". Which is only more to support my claim that the market is not as simple as the guys in mathematical finance need to believe it is so their models are even tractable with a supercomputer.

"It's the statue, man, The Statue."

by Migeru (migeru at eurotrib dot com) on Tue Mar 27th, 2007 at 05:43:53 AM EST
[ Parent ]
This sums it up as well as one could ask for.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Mar 27th, 2007 at 09:08:44 AM EST
[ Parent ]
touche.  
wc himself seems to spend a lot of effort looking at the fundamentals and investing according to his best assessment of the "available information", which means he doesn't really believe all information has been discounted, or the two-fund theorem.
but I would say this just slightly different than this.  I try to find areas of the market where I have insights, or knowledge, that I think the market has not yet taken into account.  So in my little world that most commonly happens in healthcare, where I have spent years working and investing and think, hope, I have an ability for seeing through the fog,,,,,and it's doubly good if the insight is in  small cap stock, because these are often too small to have garnered attention of the big time analysts.  So there is a company I am watching that failed their clinical trial, refinanced, and modified their drug and corrected flaws in their trial design--and I think it was too small for the market to pay attention.  so far, so good, it's doubled with some recent results.  but I'm getting a little worried because now a few more people are watching it--they could outsmart me, but I think I'll get another 50%----and this is a case where up until now I have felt I know the trading patterns for the stock a little better than others, so I have done some shorter term trading (not day trading, but month to month) and earned pocket change+.  

so I look for segments where I think the market has not yet discounted available information, or maybe said another way where the markets for some reason are not closely followed and the random walk theory won't apply, and try to make a little extra money there.  (that and the private investments are areas where insight and hard work can give me an edge).

but on calling the big companies, or the overall market trends, I find that I probably lose as much as I win--ie, a random walk.  so why not just take the index funds in those areas?

by wchurchill on Tue Mar 27th, 2007 at 02:00:48 PM EST
[ Parent ]
the vast majority of trading in the public markets is long term investing, and I've given obvious examples of this in the past.

I don't think that with a billion shares traded per day one can consider the "vast majority" is for long-term investing. If you mean that individual investors generally aren't day traders then I think you are right.

However even though people may have put their money in mutual funds for the long term this does not mean that the funds are just sitting on the money. My (very conservative) retirement fund has a turnover of over 100% per year. I assume more aggressive funds trade even more frequently.

The point is that the fund always advises participants not to try to time the market and then goes ahead and does it themselves.

Another scam is to quote expenses as a percentage of the capital invested instead of as a percentage of the yield. So a fund with an expense ratio of 1% earning 5% for the year is really taking 20% of the earnings in fees. No wonder Wall Street wants to privatize Social Security.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Mon Mar 26th, 2007 at 06:24:34 PM EST
[ Parent ]
the examples I've been using are index funds with practically no trading.  i generally don't believe in market timing, so a lot of my public investments are in idex funds.  I personally would find 100% turnover very high--but the fact that you are staying with the fund tells me they must be doing well.

I don't agree with your way of looking at the %'s.  but since I use index funds, my expense ratios are very low, so I don't worry about the argument.

by wchurchill on Mon Mar 26th, 2007 at 07:36:34 PM EST
[ Parent ]

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