This is an exceptionally good interview conducted by Jeff Sommer with the Nobel Laureate, Eugene Fama, who demonstrated 60 years ago that that short-term stock price movements are unpredictable and approximate a random walk. In doing so, Fama revolutionised finance and set the ground both for the rise of tracker funds and for the use of advanced maths & stats in investing. In this interview Fama makes four points that anyone who cares about his/her money should try to understand:
(a) The stockmarkets do NOT represent the ‘wisdom of the crowds’. Whether it is in the face of the Covid-19 pandemic or the ongoing Russian crisis, “The markets aren’t telling us much, he said. Some people interpret efficient markets as the source of “the wisdom of crowds.” This is the idea that, together, through the mediation of markets, crowds of people come up with answers about important questions that are much smarter than the conclusion of any one individual. But there’s no great wisdom evident now.
The markets are struggling to come up with prices for stocks, bonds, commodities, all kinds of things, he said. They aren’t necessarily conveying any deeper meaning.”
(b) Reading research produced by brokerages or investment houses is a waste of time. Acting upon such research is even crazier: “I asked whether he’s been reading the analyses of Wall Street investment houses like Goldman Sachs or Morgan Stanley, or of those by independent market researchers. They don’t predict how the war in Ukraine will end. But they often recommend strategies for coping with tumultuous markets in what may be the start of a new Cold War and is certainly an era of high inflation, severed supply chains and extreme volatility.
“No, he said. “I don’t read any of that. It’s investment porn,” he said.
I was taken aback. “That’s a little harsh, isn’t it?”
“Maybe. But that stuff isn’t based on deep research. What do they really know?””
(c) No matter what the data going back 10 years or 50 years shows, investing in equities is never without risk. Therefore you should always have a ‘rainy day’ fund packed away to sustain you through difficult years: “…he said, what isn’t adequately stressed in most of the so-called professional investment analysis he’s seen, “is that there is always risk in the stock market, always. It never goes away. People have to remember that.”
And, he said, it’s impossible to know which way the market is heading. “My whole life’s work says you can’t answer that question.”
The faint of heart may not want to hear this, he said, but the stock market can always go into a deep and long decline.
“We’ve done a lot of research on that,” he said. “It doesn’t matter how long you hold stocks. Some of that risk is always there.” Sure, he said, stocks have generally paid off for the long term, he said. But, he added, “How long does that have to be?”
Professor Shiller has found that, adjusting for inflation, it took two decades for the stock market to come back from its losses in the Great Depression, I said.
Professor Fama said, “Yes, but two decades might not be enough. In the future, it could be longer. Really, there’s no answer. You just don’t know. There’s always a risk it will take longer than your lifetime.””
(d) Nobody in their right mind should: (1) make predictions about the economy; and (2) invest basis anyone else’s predictions about the economy: “The Fed is likely to start raising interest rates at its next meeting, March 15 to 16. Can it bring inflation down from its current level, 7.5 percent, without causing a recession, I asked?
“I have no idea,” he said. But he has his doubts. “Unfortunately, Milton, if he were alive today, wouldn’t know either. He’d be shocked, really. He’d have to rethink everything.”
Why?…High inflation, in the Friedmanite doctrine, resulted from excessive growth in the money supply.
The problem now, Professor Fama said, is that it’s no longer possible to measure the money supply in an accurate and meaningful way. That’s because the Federal Reserve changed its approach in ways that were “unimaginable when Milton was alive,” he said….If we’re lucky, inflation will come down to a reasonable level. If we’re not, well, “that wouldn’t be surprising. It may take a recession,” he said.
Given this fairly bleak outlook, I asked what ordinary people ought to do, in the current crisis and in thinking about the future.
He was reluctant to give advice or make any predictions. “I’ve learned not to make predictions,” he said. “Can’t do it. Who knows?”
But he agreed that based on the historical data, for the long run the stock market is “probably” a good bet. He stressed, though, it was absolutely not a sure thing.
Hold whatever money you need to survive in some other asset, he said, probably in Treasuries. Then, if you can stand the stress and the risk, invest in stocks. “If you can’t handle it, you shouldn’t do it,” he said.”
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