This Year's Nobel Prize in Economics Was a Big, Fat Critique of Financial Media

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Eugene Fama revolutionized economics by proving that markets are efficient. Robert Shiller revolutionized economics by proving the markets are inefficient. Today, both share the Nobel Award for economics with Lars Peter Hansen for their contribution to the predictability (or, more often, unpredictability) of stock prices.

"There is no way to predict whether the price of stocks and bonds will go up or down over the next few days or weeks," the Royal Swedish Academy of Sciences said in awarding the 2013 Nobel Prize in Economic Science. It continued: "But it is quite possible to foresee the broad course of the prices of these assets over longer time periods, such as, the next three to five years."

Fama showed that markets are efficient, and this makes them unpredictable in the short term. Shiller showed that markets were inefficient, and this also makes them unpredictable in the short term.

Can both be true?

Sure, think about it this way. If perfectly efficient markets already reflect everything investors know, how do you "beat" them? You can't, really, unless you somehow suspect you know more than the universe of knowable information. Which is unlikely. But if inefficient markets are driven by the undiagnosable animal spirits of the investment community, how do you predict them? It's devilishly difficult. You'd have to not only outsmart a biased market, but also time your bet so that the bubble doesn't grow long enough to wipe you out.

If Fama and Shiller's research disagrees about the short term, they meet, like fundamentals and asset prices, in the long run. Shiller's research showed that periods of over-enthusiasm about a stock tend to follow periods of under-enthusiasm about a stock. The year-to-year gyrations seem wild and capricious. But the fact that they follow a pattern over the course of many years suggests that, in the long run, stocks reflect certain fundamentals, like expected future earnings. 

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These findings might strike you as familiar advice. They reflect the position of some financial advisors who tell families that frenetic day-in-day-out activist investing is for chumps, and the best place for your money is a passively managed portfolio or index fund.

But it's a disquieting idea for most of the financial news industry, whose 24-7 coverage of the market implicitly presumes an audience seeking guidance about which stocks to buy and sell each day. Daily, monthly, and annual stock picks are low-probability gambles according to Fama and Shiller's research. But they're the bread-and-butter of financial media.

Stock-pick columnists, "star" investors, Wall Street crystal balls, and assorted gurus on CNBC, Bloomberg, CNN, and across the Internet who claim they can outsmart the market are making a funny promise. If they think markets are efficient, they're promising to see obvious bargains in a world where obvious bargains should be impossible. If they think markets are governed by emotions, they're playing the role of economist and therapist, promising a get-rich-quick scheme that requires an expert psychological diagnosis of millions of investors.

Super-star stock-pickers exist. Maybe they're lucky. Maybe they're smart. Maybe they're divine oracles. But Fama, Shiller, and Hansen's research suggests it's very hard to consistently beat the market, and if somebody tells you otherwise, you should be very skeptical. 





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