Five years ago I did a post entitled Being There. I compared Warren Buffett to the character played by Peter Sellers in the famous film. I pointed out that people tend to be superstitious. They don’t accept unusual coincidences. Thus if someone outperforms the market for 20 years in a row, the general view is that it can’t be luck—after all the odds are a million to one against. People forget that just as someone must win the lottery, in any group of a million investors it is a logical necessity that there has to be one who is luckier that all the others. Here’s a test I proposed back in 2009:
I suppose this should be testable. If the EMH is correct then the top ten richest Americans should not see out-sized returns, once they have reached that pinnacle of success. I have no idea whether the data exists to do this test, but is would be a good way of resolving the issue of whether Buffett just got lucky. When similar tests are done with successful mutual fund managers, it turns out to be merely dumb luck.
At the time, many commenters claimed that hedge funds had greatly outperformed the market in recent years, disproving the EMH. It’s well known that hedge funds have since done relatively poorly. But how about Mr. Buffet? Here’s the NYT:
A new statistical analysis of Mr. Buffett’s long-term record at Berkshire Hathaway has just been done, and it’s come up with some fascinating insights about his abilities, past and present, and about the chances that the rest of us have for beating the market. Using a series of statistical measures, the study suggests that Mr. Buffett has indeed been blessed with an impressively big dose of alpha over a very long career.
But it also reveals something that isn’t impressive at all: For four of the last five years, Mr. Buffett has been doing worse than the typical, no-frills Standard & Poor’s 500-stock index fund — so much worse that it’s unlikely to be a matter of a string of bad luck. Mr. Buffett has begun to behave like an investor with no alpha at all.
Why am I not surprised? And don’t say, “it’s harder to do well when you are big.” It’s true that it’s harder to do extremely well when you are big, but it’s not hard to outperform the market when you are big, if you truly have “alpha.” To see why, assume Buffett is only able to find $5 billion in good investments each year, but has $50 billion to manage. Then put the $5 billion into the good investments, and index fund the other $45 billion. If he truly had alpha he’d still be outperforming the market.
“It shows how amazingly difficult it is to keep beating the market, even for a master like Warren Buffett,” Mr. Mehta said in an interview. “And it suggests that just about everybody else should just use index funds and not even think about trying to beat the market.”
I certainly agree with the second point, but I disagree with the first point. It should read: “It shows how difficult it is to keep winning the lottery, even for someone who has already won Megabucks.”
Sometimes people claim my
anti-EMH pro-EMH arguments have no testable implications. That’s wrong. I’ve been doing this for 5 years and again and again I’m being proved right and my critics are wrong:
1. Back when Bitcoin was $30 I did a post skeptical of “bubble” claims. The odds were probably at least 10 to one against me being right (as the potential upside was far more than downside, and hence far less likely) but I was right. Even after the recent drop I’ll be glad to buy any Bitcoins you’d like to sell me at the “bubble” price of $30.
2. I was skeptical of hedge funds.
3. I was skeptical of the Oracle of Omaha.
4. I was skeptical of Robert Shiller’s ability to give useful market timing advice. He did not recommend buying stocks in March 2009.
5. I was skeptical of the claim that the 2006 house price boom was a bubble. We now know that Canada, Australia, New Zealand and Britain did not crash, after similar price run-ups. This suggests the US crash was not pre-ordained, rather just “one of those things.”
Since I started blogging in early 2009, events have strongly supported my pro-EMH claims. Anti-EMH models are completely useless.
PS. Ok, I was wrong about one thing. Last March I half jokingly said “stock prices have reached what looks like a permanently high plateau,” echoing Irving Fisher’s infamous 1929 prediction. Yes, I was wrong—stocks have gone much higher over the past 13 months.
PPS. Noah Smith has the best piece on high frequency trading that I have read so far. (Tyler Cowen has also had some good stuff.) Noah says we know almost nothing about whether it is good or bad, and I know far less that Noah. Which suggests I have negative knowledge.
HT: Clark Johnson.