Professor Burton G. Malkiel wrote his classic, A Random Walk Down Wall Street, in 1973. The tenth edition of the book was published this year, a long term testament to its relevance not only 39 years ago, but also today.
He described the general theory supporting Random Walk (also known as the Efficient Market Hypothesis "EMH") as follows:
A random walk is one in which future steps or directions cannot be predicted on the basis of past actions. When the term is applied to the stock market, it means that short-run changes in stock prices cannot be predicted. Investment advisory services, earnings predictions, and complicated chart patterns are useless. On Wall Street, the term "random walk" is an obscenity. It is an epithet coined by the academic world and hurled insultingly at the professional soothsayers. Taken to its logical extreme, it means that a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by the experts.*
As is so often the case, a general theory becomes divided into subsets, each one addressing separate issues. The academics attacked both the fundamental and the technical forms of investing. Professor Malkiel explained the forms of Random Walk as follows:
The "narrow" (weak) form of the theory says that technical analysis --looking at past stock prices -- could not help investors. The "broad" (semi-strong and strong) forms state that fundamental analysis is not helpful either: All that is known concerning the expected growth of the company's earnings and dividends, all of the possible favorable and unfavorable developments affecting the company that might be studied by the fundamental analyst, is already reflected in the price of the company's stock.*
As you can well imagine, the Wall Street professionals did not react well to the academic criticism that their efforts were, essentially, worthless. Bradbury K. Thurlow, in his book Rediscovering the Wheel: Contrary Thinking & Investment Strategy, made what I consider a very measured argument against EMH as follows:
Indefinite, uncertain, wavering assumptions, constantly subject to change from unforeseen influences, are at best miserable companions to live with. Unfortunately, they are the essential ingredients of speculative decisions. Without them, the stock market would be totally efficient. They are the measure of its inefficiency and our opportunity for profit. Without them our activities would serve no purpose.**
It is a tribute to his fair mindedness that Mr. Thurlow went on to acknowledge the following:
In the years 1973-1977 it is noteworthy that the median performance out of the largest 500 issues was better than three out of four professional money managers. Over such a five year period a chimpanzee with enough darts should be able to achieve at least a random performance, which, in theory should qualify him for a six-figure income as one of the nation's proven top money managers.**
(Author's emphasis in bold)
We will continue our look at Random Walk in the next blog.
* Excerpts from A Random Walk Down Wall Street
by Burton G. Malkiel, copyright 2012, 2011, 2007, 2003, 1999, 1996, 1990, 1985, 1981, 1975,
1973 by W.W. Norton & Company, Inc are used with permission of W.W.
Norton & Company, Inc.** Excerpts from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, ©1981, published by Fraser Publishing Company, are used by permission of the current copyright holder.
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