I’m pre-publishing this book here, chapter by chapter, as I get each one done. As always with my “works in progress,” I welcome your input. You can share your comments and suggestions with me here.
In Chapter 1, I went back 40 years – when, for the first time in my life, I had more money than I was spending and, thus, the opportunity to do some investing. Knowing almost nothing about how the stock market works, I looked to the two men destined to be my mentors on the subject of building wealth. One who had made a ton of money by trading stocks. And one who was a strong believer in ultra-safe AAA bonds.
In Chapter 2, I enlisted Nigel, my A-I created butler, to help me determine if it would be possible to consistently outperform the market by trading stocks. He introduced me to the Efficient Market Hypothesis, formulated by economist Eugene Fama in the 1960s, which presents the idea of “market efficiency” as a way to evaluate stock prices.
Fama eventually sorted the EMH into three separate versions. Which brings us to Chapter 3, below.
Chapter 3: The Question That Can’t Be Answered
What does an efficient market look like? And who is it efficient for?
I am not sure I fully understood what all that meant. In fact, I am sure I didn’t. I nodded, to signal my appreciation of the knowledge Nigel had acquired, and he answered my nod with the dignified little bow he makes when he judges that no further conversation is required.
But I was not going to let him off that easily.
“So which version of the EMH is right?” I asked.
“I’m afraid that question can’t be answered,” he said.
“Based on everything you’ve told me so far,” I said, “it seems to me that there must be a way to test for market efficiency in order to determine which investment strategy makes the most sense.”
Nigel cleared his throat.
“Unfortunately, sir” he said, “Fama himself indicated that it may be impossible. He said as much in the lecture he gave in Stockholm when he collected his Nobel Prize in 2013.”
“Said what, exactly?”
“That when a test rejects – when it tells you a price was wrong – we cannot know whether the trouble is an inefficient market or a bad model of what the right price ought to have been. He put it in the language of equations. That is what it comes to.”
“What the heck does that mean?”
“If you don’t mind my saying so, sir, it is the crux of the matter. It is the crux of 50 years of argument. To test whether a price is wrong, you need a model of what the right price would be. And if your test says the price was wrong, you cannot tell whether the market misjudged the company or you misjudged the market.”
“So the two possibilities are welded together.”
“Precisely, sir.”
“And no amount of data can pry them apart.”
“Quite so, sir. They call it the joint hypothesis problem.”
“Which means that nobody can tell you precisely how efficient a market is, right?
“Right. Fifty years of some of the best minds in economics have not managed it, and they have said so in writing. And this may interest you, sir.”
“What’s that, Nigel?”
“Fama is still alive. He is in his late 80s and still working. I found an interview with him conducted a couple of years ago.”
He handed me a copy of it, with this passage marked:
Well, for almost everybody, the market is efficient in the sense that they don’t have information that’s not already built into prices. People who have special information, the market’s not efficient for them.
I read it twice.
“Let me see if I understand you,” I said. “You are telling me that market efficiency is not some fixed property the stock market either has or hasn’t got. It is more like a relationship between the market and the particular person standing in front of it.”
He smiled and nodded.
Efficiency Is a By-Product of Attention
Efficient for whom? That is the question this entire book turns on.
Public information does not put itself into a price. People put it there – analysts, traders, journalists – all of them arguing and continuing to make adjustments. That argument is what makes a market efficient. Take away the arguers and the information simply sits there, true and available and having no effect on anything.
Which is what JSN had found.
Nothing he knew was secret. Nobody was handing him information about a company’s private business. What he knew was who was buying. And in a market where quotes came out once a week on pink paper, where there was rarely a filing worth reading and nobody was tracking anybody’s trades, who was buying was information that that nobody had bothered to collect.
JSN collected it. Not because he was cleverer than anybody else (though he was), but because he had spent a decade standing on the floor of a stock exchange where that was the only thing worth knowing… and because he had kept the telephone numbers of the men he had stood next to.
I want to be careful here, because several things that may sound the same are not.
Trading on a public company’s private information is a crime. It’s a crime because the information belongs to the company, and because you would be using it against people in a market that exists on the promise that everybody is looking at the same page.
Collecting publicly available information about a stock that nobody else has troubled to collect is not a crime. It is called “doing the work.”
And what you know about a company from the inside because you own that company is not a crime either. It is called “knowing your business.”
All of which takes me back 40 years to the conflicting opinions about the stock market that I was getting from two men sitting 20 feet apart – both of whom knew what they were talking about.
What I was learning from Sid was that for most people – very much including me, at age 34, with no knowledge of any company whose stock I might buy and no control over any of it – the New York Stock Exchange was ruthlessly efficient. He was right.
And what I was learning from JSN was that the same market was a good deal less efficient for a man who could get someone like Danny on the telephone. He was right too.
They were never arguing about the market. They were arguing about the investment strategy that would be right for me.
Coming Next…
In Chapter 4, I discuss the little-known but vitally important distinction between outside and inside knowledge of the real value of any business transaction.
Worth Considering
Three Quick Bites
Introducing GPT-6 Astra
OpenAI’s new Frontier model – the smartest model in the world. Some people are saying it’s the first sign of Artificial General Intelligence. I think you will get a kick out of the trailer.
Disturbing!
If you are a fan of the Democratic Socialist Party, the party of Mamdani and AOC, you should be interested in this leaked video of a recent party meeting.
A Trick to Reduce Glucose Spikes
Try this after you eat something sweet.
Worth Considering
Postscript: Aries Spears, a Master of Observational Humor
This is what great comics can do. Riff on the most divisive topics and make everyone laugh.