Eugene Fama’s Efficient Market Hypothesis (EMH) has much that is of value in the theory. In fact, given the way most people invest in the markets, it is more or less the case. He himself acknowledges, and higher-level people usually do with such things, that there is a certain slippage in his theory—i.e. it’s a model, an approximation of reality and not a perfect construct. Its key premise is that investing markets, at any given time, price in all available knowledge, and therefore, that you can’t beat the markets because there is no alpha that gives you as a trader an edge. This perspective is, at least in the long term for most people trying to beat the markets, in certain ways true.
The other key school of economic market thought the behavioral market model, championed by Robert Shiller, that talks about the irrationality of crowds, of course, disputes these points, arguing that in for example bubbles the market totally misjudges asset prices. At one and the same time, you have Fama with his EMH model and Shiller with his irrational exuberance model contradicting each other. Personally, I side strongly with Shiller in this debate, but they both won Nobel prizes. Part of the problem is that Nobel Prizes or not, I would argue both theories are incomplete. Shiller’s because he provides no real model with any sophistication as to how group psychology works in practice. For this, he would need to go far astray from economics to the group psychology work in object relations theory and such writers as LeBon and Serge Moscovici. In the case of Fama, his model ignores what great traders do whether they are “investors” like Warren Buffet and Howard Marks or more strictly speaking traders like Mark Spitznagel which is, to paraphrase Buffet, wait a very long time indeed for the perfect pitch to swing at heavily. I believe EMH has key issues in that it does not address the counterfactuals sufficiently of those who consistently beat the markets, and there are such traders—it looks at the center of the curve not the outliers. However, even if EMH were correct, there is no reason at all that from time to time the market could not completely go off the rails for a while so to speak and allow for speculative opportunities, which over longer time periods get averaged away in the broader market data. Great investors like Buffet would, at those times, ramp up their investing tremendously, while at other times, stay mostly on the sidelines or simply in a holding pattern.
But I believe there is in fact a much deeper problem with their theories. Economics likes to think of itself as a harder social science more like physics with all that math and everything, but it is actually one of those social sciences most effected by power. I believe both Fama and Shiller, whatever my quibbles with these approaches may be, are brilliant and important theorists, but they might have won Nobel prizes in part and become dominant models because the work was consistent with the needs of powerful interests in markets and society as such.
Nothing is more useful to the big money and market whales than a theory like EMH that tells retail investors to buy and hold because they can’t beat the markets and allows big money to get out of positions at market tops. And no theory is more useful after market crashes than a theory like irrational exuberance that rather than blame it on a very orchestrated millennial narrative intended to get retail investors to get into bubbles and way overbid prices than to ignore how incredibly purposeful and manipulative the narrative construction was by certain powerful market leaders and blame it instead mostly on the irrational exuberance of the retail investors themselves. For a fuller discussion of some of these points, consider my note on stock market bubbles. Nothing could be worse for some, although certainly not all, of those in power than a market model that instead tells average investors they have to educate themselves incredibly, precisely to effectively not buy and hold or that markets can be in certain instances manipulated to create irrational exuberance on purpose.
Most importantly, both currently dominant models leave out entirely the one key element that does allow people, at least a few of them, to consistently beat markets and that is an understanding of political power. There is, I would argue, almost zero ways to beat the markets consistently simply within the space of the usual economic approaches. You can within that space make boatloads of money in customer fees or scalping. which is to say charging a transaction fee of some sort, the super-rich may even simply be content maintaining and slightly increasing over time their wealth, and no already big whales are trying to in most instances exponentially increase their wealth anyway, only hold onto what they have. Another brilliant area by Shiller has been his work on housing markets, and he has the Case-Shiller Index, which tracks home prices throughout the US. This research showed that over the long term, real estate prices don’t actually go up in value, the prices only go up an amount that controlling for inflation maintains their original value. If you’re trying to make lots of money that’s not excellent news for real estate unless your market timing is superb, and it also means that buying at the top of the market is an especially bad idea if you are doing so as a trade. But if you are already super rich, that’s excellent news, since over the very long term it’s almost impossible to maintain wealth. That’s assuming of course that you have the resources to still fix the roof on the castle periodically.
No, to really beat the markets and not simply maintain with some quite moderate gains existing wealth it’s not economic at all, it’s political. It’s understanding how power in all its varieties works. Power after all can make the market into whatever it wants, or power creates by its successes or failures incredible opportunities. The world’s greatest traders do not make economic trades, they make political trades.
I’ll give you a few examples that should at least get you reflecting:
Citbank’s number one trader supposedly in the world in 2011, Gary Stevenson, has a number of YouTube videos where he describes what he actually did to make all that money. Was it because he was a math whiz, which he was? No. Was it because of his knowledge of the usual economic theory? Not really. He tells us what he figured out was that the economies in the West were not going to improve but decline over time and that the elites were going to let that occur and do nothing to try to stop it. He simply placed a long-term speculation with tons of money that those countries would decline.
In other words rephrased in political terms not economic terms, and assuming that it was not simply some oversight but purposeful, which he leaves unstated, one could say that he put on a trade that some elites were going to wipe out the middle class and basically steal from their own countries, or at least that they would not be able to curtail the forces creating this result, and he simply placed a long term speculation that those countries would decline over time. That, my friend, is a political trade.
He leaves out what caused that decision in the first place that ultimately led to that particular historical moment, so let me fill that in a bit based on a theory about this I was once told years ago. I’m not sure if the theory about how this occurred has merit or not but it’s entertaining, so I’ll tell it: After the Cold War, the West was victorious, and they expected all the spoils to come to them. They could have done a Marshall Plan in Russia and made the world completely over, but they wanted their victory and revenge so they didn’t welcome a potentially democratic Russia into the West. In part, they still felt the pain from all those Cold War years, and it was very personal for many people, which was perhaps not the right move politically but at least understandable. The Cold War had been very brutal in so many ways. Or perhaps they simply thought a weaker Russia was less of a strategic threat. Perhaps, they did not want to run the risk of the ex-Soviet bloc becoming more democratic than their own countries—that would not have been great for some of those in power at all.
In any case, the point is that they had their victory and wanted their desserts so to speak. But fairly quickly Russia became closed for business; it became too dangerous for Westerners. Some other parts of Eastern Europe perhaps not so much. But Russia was also where the most wealth in Eastern Europe was found–all that oil, all those resources. Russians, who had connections and were talented and reflective and risk takers, could become suddenly incredibly rich basically taking and selling everything that wasn’t nailed to the ground in some cases, or more legitimately in other cases gobbling up entire companies and sectors now freed as capitalist enterprises, and so they did and when they got rich knowing all the risks in a largely lawless chaotic country at that time, they took their money out and got it often elsewhere to safer places in the West. Obviously, with the account I’m repeating that I heard, I’m painting with broad brush strokes, but you get the idea. Putin ultimately, whatever his democratic issues which are considerable, put an end to that unruly process in Russia and reestablished order, but at least for a while tremendous wealth was being transferred out of Russia to, often, Western cities where that wealth was more secure.
Also, with the global economy as a whole opening up after the long freeze of the Cold War, countless new super-rich were forged in many hitherto second economy locations. Those new super rich also moved, in many cases, their wealth to more secure Western metropolises. And according to this interesting account, how do you think the powerful in those cities felt when they found themselves in places like New York City or other western power centers competing with newly arrived Russians with beautiful wives or girlfriends and amazing condos that, in some instances although certainly not others, dwarfed their own or with other rich folk from around the world with seemingly more money than them, with this new class of global super-rich? They were like how come they get to extract all that wealth from their countries, and we won the Cold War and don’t get to have the same level of spoils? So according to this account, which might or might not be accurate, some of these elites in the West began in earnest to copy the model emerging in the rest of the world and started doing the same thing and extracting as much wealth as quickly as they could from their own countries.
After all the Cold War was over, there really was no threat to the West and more specifically to the hegemonic United States at least for a while, so if they hollowed out their own countries a bit, they wouldn’t lose their power from external enemies anyway. The way this was done in the Western countries by some of these elites was simple, and I won’t for obvious reasons mention specific companies or people. I am also not suggesting that all elites in these countries took this course, many did not and simply tried to rightly strengthen the better victorious capitalist system and take advantage of new opportunities. But those that did take this more predatory course simply bought a US or Western company with often borrowed money, closed the businesses in the US or Europe, moved the business to China or some other far off place so to speak, got rid of all those workers, in certain cases even hollowed out the middle class and some of these communities, used much cheaper labor found elsewhere, and then sold the goods back into the US or Europe. In Eastern Europe and other global locations around the world in certain cases, the stealing of some of these countries resources for a while was sometimes direct, but this when it did occur in the US and West was indirect and had the same result.
Or perhaps what was happening in Eastern Europe and other far off global locations had no direct effect at all on this, and this account is wrong and certain powerful interests in the West just figured this game out after the Cold War ended. After all, the principle of free trade now fully unleashed after the Cold War was over suggested that if you could produce goods cheaper somewhere else, you should or your competitor would. The great financial analyst Gary Shilling, who accurately predicted the crash of the housing bubble in the 2000s, once the story goes asked the great free market economist Milton Friedman at a social gathering whether the theory of total unhindered global trade wouldn’t have to inevitably equalize wages across the entire world and lead to a large decrease in wages by advanced economy workers. Friedman argued it would not have to equalize which I’m not sure is actually consistent with his theory and Shilling was unconvinced. But if Shilling was right either way whether predatory or not, same result. Of course if this was the case at some point national politics would inevitably get in the way of this process before its completion as the political cost would become too high. How would Fama or Shiller’s models deal with aspects like this narrative, one wonders?
So how did the most supposedly successful trader at Citibank make his money a couple decades later: by understanding either directly or indirectly that trading this crucial power event, which was reaching a new later level of negative effects, was the key to the markets they were trading, and getting on the right side of this trade. It was a trade based on politics.
Let’s take another famous example–George Soros’s billion-dollar trade against the Bank of England in the early 1990’s in which he speculated that the Bank would have to let its currency float after entering the European Exchange Rate mechanism. You can read about this famous speculation in a million places, so I won’t go into the details. In brief, what Soros did however is politically conclude that there was no way that the Bank of England could withstand the political fallout from raising interest rates enough to preserve the currency or have enough money it could use to support the currency given the political climate in England. Theoretically, the Bank could have countered and wiped out his speculation. A central bank has incredibly deep pockets no trader should be able to stand up to. What he knew, however, was that politically they would not have the will nor room to move to do so. My only point is that this is also a political trade concerning the ways in which the central bank was constrained in terms of power and had to ultimately give in on the trade and also its general political situation both within England and a new broader European political setting. The result was his fund made around 1.5 billion dollars in a single trade that lasted several weeks. As suggested earlier, Soros waited for his pitch and when it came, he swung with all the power he could muster. How does EMH explain a moment like this or a reflective trade like this, and how could the usual economic theories understand it, since it ultimately depends on a political assessment? Now, I would only add that Soros has been incredibly politically active for decades no doubt for personal reasons but also because that is, for better or for worse actually the key, I would argue, to his trading style. Add political power to his reflexivity model, and you get something from a theoretical perspective anyway interesting indeed.
Let’s consider another example, the great trader Sir John Templeton. His model for investing, I would suggest, ultimately depended not on the usual market concerns, which were often just window dressing, but on appraisals of what was happening with political power in countries around the world. A recent example is the election of Javier Milei in Argentina. It’s the politics of Milei’s victory that has moved that market so high so quickly. Economics here follows politics not the other way around. Sir Templeton chose Lyford Cay in the Bahamas as the place to live perhaps not because of its idyllic island qualities, which are certainly the case, but, some people have concluded in accounts of his life, also because it gave him access to political information from all the diverse super powerful global figures found there in social settings like the famous Lyford Cay Club about politics in lots of locations around the world.
Ask yourself why NVIDIA is moving up like it is: Is it just because it’s bringing computing power for years only the province of powerful governments to the people which it does or is it because it promises to be an incredible control mechanism, something I’ve discussed elsewhere. In other words, it might be the world’s most successful stock also because of political power that wants to use AI for control. Now don’t get me wrong, there are many useful things about AI, and the fact that it gives the US an edge against its adversaries is certainly one of them. Also, it doesn’t hurt that all those server farms with their computing power will be required for AI and, of course, can be used for lots of things.
Did Facebook magically rise so quickly to mega status as a stock, or does it ultimately owe in part its rise to the fact that it provides a dream come true for the modern surveillance state, a means by which people on their own provide complete transparency about their personal networks, photos and everything? When Facebook first arrived on the scene was all the media coverage it received an accident? Could you have decided it was a great market trade based on economics alone without considering its role in terms of power? Where in either Fama or Shiller’s models is there a place for these kinds of questions concerning power?
Did all those dot-coms go broke in the earlier 2000’s market crash because they were too over-leveraged, which is true, or did they actually go broke when their valuations became so great that they threatened the power of the existing elites more traditional companies, not just in terms of economics but also in terms of the power structure itself? Personally I can almost date the moment of the crash to a day when there was a huge divergence all of a sudden between the old economy as represented by the DJIA and the new economy represented by NASDAQ and one knew it was time to head to the exits before the ensuing stampede. Some of those in power might have let the dot-com bubble go for a while to make lots of money off of it, but not to the point where it undermined their own broader established power. None of these kinds of issues are addressed by the existing dominant market models.
Nor is power merely confined to even the normal market principles and sphere at all.
Tons of illicit money circulates the globe, and it involves power also. Where is there a place for such aspects in either Fama or Shiller’s models?
There are those who have argued for years that some of the housing bubble in the mid 2000s was fueled actually by money laundering through real estate. Certainly, at least part of the real estate bubble in an earlier period in big global cities like New York involved party bosses in faraway countries and corrupt money seeking to get assets into the safe haven of New York City real estate. Not that this was even illegal in many cases, but it certainly could have overdetermined certain sectors of real estate. As the more expensive properties inflated buyers were forced to drop a notch in turn inflating the next lower level, etc. Also, it’s been suggested that real estate might have been used by illicit money more generally throughout the economy in corrupt ways. When the real estate market crashed not only did the economy crash, but perhaps much of the entire paper trail of market transactions became an impossible path to follow. It all disappeared into a chaos of what was in many ways untraceable red ink.
When this real estate bubble crashed where did that corrupt money go? Who knows, but you could have predicted the rise of bitcoin in terms of its role in hiding corrupt money and its toleration by powerful governments who in all likelihood then had a digital trail for a change to follow at least some of that money. The weakness experts have suggested with bitcoin for corrupt money is that the price unlike something like gold can fluctuate tremendously, but still some percentage of corrupt money must be there. No doubt as bitcoin becomes ever more accepted even more illicit money has gone there. Could EMH or Shiller’s models even account for such elements as they effect markets? Or how does one deal in these approaches with the fact that as much as 78 per cent of 4.9 billion dollars in crypto startups in one year may have been scams.
What, one wonders, would EMH or Shiller’s irrational exuberance theories do to explain the sudden rise of Miami and Southern Florida as a result at least in part–and there were many other factors also involved–of huge amounts of illicit money flowing into that state in the 70s and 80s. Would either of these theories have said it was a good trade to buy cheap condos or invest in banks in the region–both obviously legal investments–because it became clear what was occurring there and at least some of the politically powerful for whatever reasons were more or less tolerating this huge influx of illicit capital at least for a while.
At a broader cultural and economic level would those same models have understood at all the issues for the markets there in that key region and effect on the economy of the later Cuban boat lift by Castro or even the much earlier initial takeover by Castro of Cuba sending liberty loving Cubans to Florida in the first place. How could you possibly talk about investing in such urban areas without adding these two key general and very important political events?
Hopefully, these few examples, and there are countless others, suggest that any model of beating the markets that thinks that can be done in terms of economic concepts and models only and not consider power and politics is radically incomplete. In future posts, we will begin to give the outlines of a more complete model.
Disclaimer– the information discussed is simply one person’s opinion nothing more or less. It is only for entertainment purposes. By using this blog, you assume all risks associated with using this advice, suggestions, information, conclusions and everything else contained here-in and that you completely and fully understand that you and you alone are 100 per cent responsible for anything that occurs from using this information and material in anyway whatsoever–regardless of how you interpret any discussion, conclusions or advice contained here-in. Any discussion of actual stocks or investments is in no way a recommendation and is only for educational purposes. You should listen to many competing opinions, consider all the counterfactuals to what is argued, seek out always if necessary professional advice, and of course ultimately make your own decisions about the markets.