Buying Stocks

EMT also cannot explain many other things about how market prices operate apart from swings, bubbles, and crashes. Abundant evidence refuting EMT includes the extraordinary number of unexplained market phenomena, such as the following:

•  The January effect (prices tend to rise in January).

•  The insider effect (a stock's price tends to rise after insiders dis­
close purchases to the Securities and Exchange Commission and
fall after insider sales are disclosed).

•  The value line effect (stocks rated highly by the Value Line Investment
Survey tend to outperform the market in terms of price).

•  The analyst effect (stocks of companies followed by fewer analysts
tend to become pricier compared to those followed by more ana
lysts).

•  The month effect (stock prices tend to rise at the end and the
beginning of months).

•  The weekend effect (stock prices tend to be lower on Mondays
and higher on Fridays).

Weirder correlations also exist, including the hemline indicator (prices historically have risen and fallen in tandem with rises and falls in the average length of skirts in fashion) and the Super Bowl effect (prices tend to rise in the period after the Super Bowl if the winning team was a member of the original National Football League but fall otherwise).

Efficiency buffs call these and dozens of other well-known exhibits against market efficiency "anomalies." Some anomalies disappear over time. The January effect began to do so in the mid- 1980s. When they do, EMT worshipers rejoice, citing the disappearance as evidence of stock market efficiency. This is strange evidence, however, when you note that the vanished anomalies persisted for decades (seven decades in the case of the January effect).

Even more bizarre, the anomaly label has been applied to the astonishing investing records of many prominent stock trading, a list that is long and getting longer. It includes Ben Graham; Warren Buffett; Charlie Munger, vice chairman of Berkshire Hathaway; John Maynard Keynes; Bernard Baruch; Gerald Loeb; John Neff of the

Windsor Fund (Vanguard); Mario Gabelli; David Schafer; William Ruane and Richard Cuniff of the Sequoia Fund; Tom Knapp of Tweedy Browne; John Templeton; Mason Hawkins of Longleaf Partner Funds; and untold others.

BARREL OF MONKEYS?

Can it be, as EMT devotees resort to saying, that these are anomalies too—that these folks are all merely lucky? Is it plausible to believe that they are just like the imaginary monkey who would produce the entire script of Hamlet by randomly hitting the typewriter keys? Even if you agree that this is possible, to complete the argument the imaginary monkey would also have to be able to punch in the correct keys to generate the full scripts of Romeo and Juliet, Macbeth, King Lear, Henry IV, and pretty much the entire Shakespearean canon. Even if this is theoretically possible, such a prolific monkey (or a barrel of monkeys) seems incredible.

The monkey view acknowledges that luck plays a role in investing, as it does in other aspects of life. The leading populist apostle of this "lucky monkey" viewpoint is the Princeton professor Burton Malkiel, who explains it in his book A Random Walk Down Wall Street by using a coin-flipping contest. 10

Start with a thousand people flipping a coin, with those flipping heads being the winners and going to the next round. By the laws of chance, on average 500 will flip heads and 500 will flip tails. The 500 flipping heads proceed to round two, where, again by the laws of chance, half will flip heads and half will flip tails. The 250 lucky heads flippers go to round three, where 125 of them win; 63 of those win round four; 31 win round five; 16 win round six; and 8 win the final round and are proclaimed "expert" coin flippers.

Yet resorting to luck as an explanation of investment success leaves the explanation incomplete. First, investing is simply not like coin flipping, though speculation and gambling may be. The great investors do some homework and develop a set of investment precepts to guide them in their selection of investments. They don't simply flip a coin in choosing which investments to make. They certainly do not decide between, say, IBM and Clorox by pasting their logos onto a coin, with the logo landing face up getting the capital.

Second, the lucky monkey would have to have been banging on his keys every day for decades, much as a day trader would have to click his mouse every day for decades. But the great investors have not followed the daily trading strategy. On the contrary.

Buffett, for example, generated most of the billions of wealth Berkshire Hathaway has accumulated from about ten investments over about forty years. Many of those billions came from buying stocks big stakes in large companies at times when their value was woefully underappreciated by the market.