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David D. Kirkpatrick and Jamie Heller

the breakfast table
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from: David Kirkpatrick

The Wall Street Casino

Posted Monday, May 22, 2000, at 1:32 PM ET

Jamie--

This is fun. We disagree some, but we care about the same stuff. You're right about the Berenson article: It's not quite as Panglossian as I made it out to be. Whether less or more efficient, the markets move around fast because investors are digesting a ton of information. I still don't buy it myself. The amount of information available has always been near infinite. People's thinking hasn't got any faster. Just because I subscribe to more magazines doesn't mean I read faster or get more reading done. In fact, in the New York Review of Books alone pretty much swamps me.

Of course, I'm talking heresy, not apostasy, if you know what I mean. Like other thinking people, I believe the markets are efficient in the long run. But in the short run--fuggedaboutit. Say a big mutual fund, the mammoth David Kirkpatrick Fund Management Inc., wants to sell a lot of stock. I try to do it carefully--dribbling it gradually out through a chain of brokers and intermediaries, none of whom really knows the full size of my intentions. But they all gossip, too. And before long the rumor has got out that I am selling millions of shares of Microsoft stock. So buyers, seeing the new supply, pull back, knowing that if they wait they will get a lower price. Eventually, I get my selling done. But when I assess the cost, I need to figure it the impact on the price I got. And the cost was much higher than the "real" consensus price.

Then consider everybody else in the market. Some clever insiders might have made some money just be stepping ahead of me. Lots of other people bought or sold at an oddball price, while the market gradually made it way back to consensus. So in theory, the market is efficient. In practice, at any given moment, it's hard to call the prices real consensus prices. My point is just that inefficiency can lead to more inefficiency by encouraging a casino or momentum mentality and taking away the credibility from market prices.

The B2B phenomenon wasn't new information, by the way; it was a fad, like e-retailing, online communities, and Web portals before it and wireless Web companies today (unless I am behind). That's not news; that's a herd mentality, goaded on by Wall Street analysts inventing new "themes" to tout their funds' underwriting clients.

As for momentum traders, you aren't really saying you think that is a wise way to try to invest, are you? You're really just trying to provoke me because you picked up on my slightly moralizing tone. Well, what can I say--you are right. I think the capital markets have an important role to play in the economy--allocating capital and all that stuff. If they run like a casino, they work less efficiently.

Anyway, sure, caveat emptor. If someone wants to trade like a nut, let him or her. But the structures and rules that govern the securities industry are worked out in Washington, and whether those rules make the markets as fair and efficient as possible is a perfectly legitimate issue for public debate.

OK, I might as well admit, it is also true that I haven't had much money in the market during the bull market of the '90s, so I am prone to sour grapes.

As for index funds, it is true that they trade less often than actively managed funds, so they have lower costs. But that is a different point. Index funds still have to buy and sell in large volumes, and they face the same problems as other institutional investors when they adjust their holdings. The folks at Vanguard are among the most articulate in the industry about trying to keep their trading costs down. My point is just that volatility raises trading costs for funds of all kinds, and of course higher trading costs strengthen the argument for indexing (a close cousin of the efficient market argument).

As for the New York Post article, I will take a look at that this afternoon. But you know what? I'll bet we disagree again.

Can't wait.

David

the breakfast table
entries
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from: David Kirkpatrick

The Wall Street Casino

Posted Monday, May 22, 2000, at 1:32 PM ET
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David D. Kirkpatrick is a contributing editor at New York magazine who writes frequently about business and finance. Jamie Heller is editor for strategic ventures at TheStreet.com, where she's worked since its 1996 founding.
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Reader Response from The Fray--to be read after the most recent entry:


I still don't understand how the stock market can be efficient in the long term and not the short run. And I'm not relying merely on Keynes' famous sentiments about the long run; my point is even simpler: when is the long run? Was Microsoft's long run value from 1990 to early 2000 or to today? Short run volatility must have consequences for people who claim long run efficiency. To my mind, and for many other reasons, believing in efficient markets is like believing in Santa Claus--there are correlations between expected results and reality, but people really ought to grow up and accept that no-one on Wall Street knows anything.

--Jeff

(To reply, click here.)

(5/22)

To Jeff: Various natural processes are long-term efficient without being short-term efficient, for example the downhill flow of water or the process of natural selection (aka evolution). Complex human processes seem to have similar behavior. Perhaps efficient is being confused with "optimal". The problem with most strategies that attempt to be optimal is that they often have truly horrendous failure cases, which wipe out all their interim or theoretical gains. Democracy has been called "the worst form of government, except for all the rest." It is hardly optimal, and in many cases very inefficient. A dictator could get the graffiti cleaned up and the trains running on time; democracy seems to have a hard time doing such things. But what about the failure case of a less-than-benign dictator or a dictator whose benign intentions diverge from many or most of the desires of the population? An example of short-term efficiency vs. long-term, in terms of human happiness.

That's not to say short-term efficiency is bad, or that we can't improve on raw systems. But it is possible for a strategy to be the best long-term one without exhibiting short-term efficiency.

--Paul Canniff

(To reply, click here.)

(5/23)

Washington Post
The Washington Post
OPINIONS
Topic A: Obama's Speech
| Pundits and diplomats respond.
Robinson: Sunshine in BerlinToles: The World ?'s ObamaTelnaes: Meanwhile, McCain