October 6, 2005

Investment advise paradox

Found this good article (below) on wallstraits.com. I have wondered several times the same point – ‘if the stock tips are so good and reliable’ then why are they being given out for free or for a fee. Put it another way, all these experts on the TV channels and websites who claim to know where the market is going ..why are they letting others onto it or selling this advice for a fee. Can these ‘experts’ not getting rich by following their own advise? Replace the work expert with  broker and this paradox is even more jarring !

It is ironic that two approaches to stock market investing that would be widely accepted in the prosperous second half of the twentieth century—Graham and Dodd’s “value” investing and T. Rowe Price’s “growth” investing—were spawned within a few years of each other during the depressed 1930s. Neither Graham and Dodd nor Price anticipated the long boom that would finally get under way in the 1940s. But the analytical approaches they developed, even though profoundly colored by the searing experience of the Great Depression, proved to be very durable, providing systematic methodologies for investing that would be successfully employed under very different conditions in the future.
At the same time Benjamin Graham and David Dodd were writing Security Analysis (1934), another student of the market, Alfred Cowles, was collecting data in an effort to answer a basic question that intrigued him. Seeking sound investment advice, Cowles had become confused by the bewildering array of investment newsletters published in the 1920s. He finally decided in 1928 to conduct a test in which he would monitor 24 of the most widely circulated publications to determine which was actually the best. The results of his efforts proved quite disappointing; none of the services correctly anticipated the 1929 crash or the subsequent bear market, and most of the advice offered proved to be quite poor.
It was then Cowles asked the question that he would spend years attempting to answer: Can anyone really consistently predict stock prices? Using his inherited wealth to fund research on the subject, Cowles assembled a great deal of data and eventually reached a tentative answer to his question. Summed up in three words, the answer was “It is doubtful.”
Cowles found that only slightly more than a third of the investment newsletters he monitored had performed well and that he could not prove definitely that the results of even the best of them were attributable to anything other than luck. He also took on the proponents of the Dow theory, exhaustively examining the predictions of William Hamilton, the Wall Street Journal editor who succeeded Charles Dow. For more than 25 years, Hamilton had been publishing market prognostications based on Dow’s ideas. Hamilton died in 1929, shortly after issuing, only days before the crash, his most famous prediction: that the bull market of the 1920s had come to an end. He received a great deal of posthumous credit for his timely market call from observers who forgot that he had made similar calls in 1927 and, twice, in 1928. Cowles did not overlook the previous faux pas; his analysis concluded that although a Hamilton portfolio would have grown by a factor of 19 during Hamilton’s years as editor of the Journal (1903-1929), an investor who simply bought into the market and held his stocks over that same period would have done twice as well.
Cowles, although not a trained academic expert, compiled an impressive array of information that would be used decades later by scholars seeking to examine the same questions that had interested him. (Much of the data used in this book to compute price-earnings ratios and dividend rates for the nineteenth and early twentieth centuries comes from Cowles’s work.) Cowles founded the Cowles Center for Economic Research in Colorado Springs; the facility was moved to the University of Chicago in 1939 and would over time support the work of many Nobel Prize-winning economists. But in the 1930s, Cowles’s insights were understandably unpopular with professional investment advisors, most of whom preferred to ignore his conclusions.
What must have been most galling was a simple point Cowles often made that was never answered effectively by the investment advice practitioners. As Cowles put it, “Market advice for a fee is a paradox. Anybody who really knew just wouldn’t share his knowledge. Why should he? In five years, he could be the richest man in the world. Why pass the word on?”
In spite of the conclusions he reached, Cowles never doubted that investors would keep buying newsletters. As he put it, “Even if I did my negative surveys every five years, or others continued them when I’m gone, it wouldn’t matter. People are still going to subscribe to these services. They want to believe that somebody really knows. A world in which nobody really knows can be frightening.”  
Credits: This article is primarily extracted from B Mark Smith's market history book, Toward Rational Exuberance, 2001.

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