One of the most consistent themes among mainstream analysts is that market timing doesnʼt work. Though the market may show some particular tendency over a span of time, the effect will inevitably disappear, they claim. All such apparent patterns are simply the effects of randomness. The market is a near perfect discounting mechanism. Everything which could be known about a given stock is already reflected by the price. In essence, the myriad forces push and pull on stock prices in a way that is effectively impossible to predict. Trying to predict prices action through, say, price patterns or support and resistance levels is seen as futile. The best the average investor can hope to do is to stay invested all the time under the assumption that prices will generally rise. Perhaps one of the best known of these theorists is Burton Malkiel. Widely cited and praised, his book A Random Walk Down Wall Street has been through seven printings since it first appeared in 1973. Attacking both technical and fundamental analysis, he essentially argues that all analysis is futile. Like many of his ilk, he argues the best thing to do is to buy a “diversified” portfolio of stocks and hope it rises.

Obviously it would be senseless to simply dismiss his views out of hand. In fact he raises some excellent points. For example, it is certainly true that the bulk of fund managers, newsletter writers and (public) Wall Street notables are notoriously poor at beating the market. In fact, about 75% of public equity funds underperform the S&P 500 over extended periods. This is one of the most important arguments against the use of mutual funds. I generally agree that if one is to be in the market at all, it is better to simply buy an index ETF than it is to spend excessive fees on fund managers who will probably underperform the market anyway.

Nonetheless, there are a number of problems with the general theory. First of all, Malkiel (and many other proponents of the random walk theory) often overlook the essential lessons it offers when it becomes convenient to do so. For example, while he spends first third of the book explaining why it is futile to look at either technical or fundamental factors when constructing a portfolio, he then introduces a list of “Potentially Useful Stock-Picking Rules” beginning on page 386. Interestingly his very first rule calls for investors to “Confine stock purchases to companies that appear able to sustain above-average earnings growth for at least five years”. If ever there was a factor which would be considered a true “fundamental” it would be earnings growth. A firm, after all, is supposed to make money. Those earnings, and their intendant growth (or lack thereof) surely represent some the most discussed components of a firmʼs operations. Far from offering a counterpoint to traditional Wall Street thinking, this represents almost a slavish imitation of it.

While he notes that the job is “difficult” (p. 387) he still maintains that picking stocks with consistent earnings growth “not only increases the earnings and dividends of the company but may also increase the multiple that the market is willing to pay for those earnings” Of course if one had been at all attentive to the lessons of the first portion of the book it would have been firmly concluded that consistent future growth was: a) virtually impossible to predict and b) would already have been factored into the stock price by the time the investor could have taken action. I cite this simply to point out a particular instance of a contradiction.

More broadly we can see that such contradictions are almost inevitable among proponents of the random walk. Or at least so long as the proponents stay involved in the business of analysis. After all if they are employed by a brokerage house or university, they are going to be required to “do” something. But were they to really stick to the theory, their activities would be confined largely to running random number generators on lists of stocks. In fact, they usually wind up analyzing essentially the same kinds of things that the rest of the mainstream analysts do.

In my view, the tremendous popularity of the random walk hypothesis among the university crowd has less to do with any intrinsic merit it might have and more to do with its propensity to deliver cadre of a middling, mainstream disposition. Obviously it would be very threatening to the Wall Street insiderʼs profits if a truly concerted effort were made to deliver superior market timing among, for example, mainstream fund managers. They might actually start buying bottoms and selling tops, rather than the reverse, which would be a nightmare for those who make a living trading against the public.