Is the market really a random walk? Is the market really efficient?

books:


	• A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition Burton G. Malkiel W. W. Norton, 2007 - 416 pages average customer review:based on 52 reviews view larger image
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highly recommended

Is the market really a random walk? Is the market really efficient?

This a great classic book by a highly distinguished academic.
It is a fascinating book in all of its editions through the years, not the least because it stimulates thought.
I have one rather significant difference with Professor Malkiel.
On page 253 of the hardbound editon the author writes about the "The Dividend Jackpot Approach". On page 254 the graph clearly shows the historic evidence indicating that future stock returns are higher (and risks lower) when the current dividend yield on stocks are higher rather than lower. So far so good. That is correct.
But then the author that these finds "are not nessisarily inconsistent with efficiency. Dividend yields of stocks tend to be high when interest rates are high, and they tend to be low when interest rates are low"
I don't know whether that is true on a statistical basis. I believe that John Bogle of Vanguard fame has done some work on that issue, and failed to find a statistical relationship between stock yields and bond yields.
In any case, I can think of some extremely important times when stock dividend yields did not reflect interest rates generally.
In 1946, for example, stock dividend yields were extremely high, around 8%, whereas interest rates were extremely low. Low term bond yields were in the range of only 2%.
Those investors who believed in buying value would have bought stocks and sold bonds. Those investors who, to the contrary, believed in efficient markets, would have thought that stock dividend yields and bond yields were simply reflecting economic conditions. The efficient market enthusiast would not have bought stocks and sold bonds.
Guess what? It was a great time to be in stocks and out of bonds. Bond investors lost considerable amounts of money in both nominal and real terms in the years after 1946. Stock holders had some great years. Efficient market enthusiasts were wrong.
Those of us who were active in the markets in the year 2000 may find it difficult to accept the efficient market hypothesis based on our experience in those years.
In the year 2000, stocks were bid up to the point where the Standard and Poor 500 were yielding only 1.15% from dividends. The Fed funds rate averaged 6.24% for the year 2000, Moody's AAA corporate bonds averaged 7.62% yield for the year. Those of us who look at value could not quite figure out how the stock market as a whole could possibly be a good buy in the year 2000. I didn't seem to make any sense at all.
Those who believed in the efficient market hypothesis advise investors not to try to pick value, not to try to market time, because the stock market is simply too efficient for that. They assured investors that stock priceds simply reflected economic conditions in 2000. They advised investors to stay with stocks, and even to continue to buy stocks on a dollar averaging basis, even in the year 2000 when stocks appeared to be so terribly overpriced.
Well, as it turns out the efficient market investment advisors turned out to be wrong, disastorously wrong. There was a correction in stock values starting in the year 2000, and stock prices fell very significantly until the end of 2002. Bond prices, on the other hand, were an extremey good buy in 2000.
This was not rocket science. It just didn't make common sense to be buying or the holding the broad stock market index in the year 2000, based on a simple calulation of relative yields.
In 1946 and in 2000 stock dividend yields did not in fact simply reflect interest rates on bonds. The value investor would have done much better than the efficient market investor, and this has been repeated many times in history.
So while this book is a great fun read, and an investment classic, the average investor should be aware of substantial evidence to the contrary of that presented in this book.
There is another point of view.

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Well-written, has the right caveats

This classic has been updated. Malkiel writes in a clear manner. The life-cycle chapter is particularly well done. This book is worth the purchase price, to say the least.

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A classic that should be on the bookself of every investor

This is the updated and expanded 9th edition of a classic investment book that everyone should read once. Although the topics visited are rather extensive, Dr. Malkiel has a very fluid writing style and reading is easy.

Dr. Malkiel believes in a weak form of efficient market hypothesis in that although there might be inefficiencies at times, consistently finding and taking advantage of these are rather difficult after expenses and taxes even for professional money managers and many fail and ruin their investment in the pursuit of beating the market on the long term. Dr. Malkiel suggested investing in broad market (i.e. index fund) in the first edition before first "retail" index fund became available from Vanguard.

The book begins with a brief review of two valuation models: firm foundation valuation and castles in the air valuation. The next couple of chapters are about market manias and bubbles from ancient times to most recent dot com bubble and points to valuation changes and irrational investor behavior. I think every investor could take home something from this review. Those that do not know the history is bound to make the same costly mistakes.

Dr. Malkiel than examines technical analysis and fundemental analysis and market timing strategies and their shortcomings. He associates the technical analysis to astrology and how different securities analyts/researchers using the same fundemental anaysis end up with completely different valuations.

The new chapter on behavioral finance is a must read review of irrational investor behavior and show how investors could be their own worst enemy.

Rest of the book is a useful review of how an investor could construct a reliable portfolio considering risk, diversification and investment products such as individual stocks, mutual funds etc. Several model asset allocations are also available. While I found this section useful, for an investor looking for more specific guidance on portfolio construction, I would like to point to another book, The Four Pillars of Investing: Lessons for Building a Winning Portfolio (Hardcover), for futher reading.

Other investment books I recommend:

The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Hardcover)
Capital Ideas: The Improbable Origins of Modern Wall Street (Paperback)

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Must read- Common sense advice for Wall Street novices

This is the first book I read outside normal econ/finance textbooks. The 7th edition is updated with a chapter on behavioral finance, which explains thoroughly the irrationality of the market or the hype/bubble that is no longer rare today. The book is awesome and useful for novices desperate to become a real investor. In short, the Princeton professor Malkiel concludes that buy-and-hold is the one and only strategy and index fund is the way to go. Malkiel also cautions that since S&P 500 indexing technique has been exploited for a while, it is better to increase the number of small companies-other kind of stocks and funds i.e. index MORE. A comprehensive list and tables of different mutual funds are provided with a moderate preference for Vanguard. I particularly found the chapter on retirement fund exceptionally valuable. At 20, probably you don't think much of 401k or annuity. Read the book, you will think differently AND invest more wisely. Disclaimer: If you have a gambling bug and like to pick high risk-high return stocks, note that Lady Luck does not always stay with you. The future CANNOT (this is repeated several times in this book and in several other books as well) be predicted by the past. Your chart analyst may protest. But hey, we have bull and bear periods as well as big crashes in the US, UK and Asia. You name it...

In a nutshell, read the book but don't worship it like a bible. Any best selling guide is for the mass. You don't want to be part of the crowd. Keep your critical mind. I believe that once you are in Wall Street for a while, you will think differently from Malkiel in 2007.

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The Only Investment Book You Will Ever Need

This book is excellent. It advocates maintaining an asset allocation of stocks, bonds, cash etc., that is appropriate for your age and risk tolerance. The stocks should be in a low fee total market stock index fund or in an exchange traded fund ETF. Read the book for the proper mix of stocks and bonds to maintain in your portfolio for your age.

I read a copy of this book about 23 years ago and did not follow its advice because I thought I could outsmart the market. I subscribed to many financial magazines and newspapers, thinking that knowledge is power. I found that you can get as many bad tips as good tips. It's basically a flip of the coin. With the advent of the internet, I searched the internet for the latest recommendations from the famous gurus of the day.

During the recent bear market of 2001, a very famous bond guru predicted that the Dow with go to 5000. It wasn't until the Dow turned up substantially before the bond guru admitted his mistake. There is also a famous Dow Theory interpreter, who writes a monthly newsletter. He hinted that the Dow would go to 3000 and the total stock market index of 5000 stocks would lose about half its value to 6000. He was very bearish when the market turned upwards in 2003 and stayed bearish until recently, as the Dow is at an all time high. Many of his subscribers are very angry at him because his bad call kept them out of the market for the bulk of the recovery. It appears that it is more profitable to sell advice than to take it.

Following the advice of gurus can be detrimental to your financial health.
I've learn that recommendations from gurus and financial publications have an equal chance of being a good or an asinine idea. Financial magazines and gurus have ZERO predictive value and they want to get you into a dependent relationship in which you are waiting for the latest hot tip month after month.

This book recommends that you cancel all subscriptions to financial publications and newsletters and just maintain the appropriate asset allocation. This is very good advice. It will save you countless hours of useless research. After 23 years, I'm back to square one and I will now follow the advice in this book.

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reviews: 1, 2, 3, 4, 5, 6, page 7, 8, 9, 10, 11

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