The following is in response to Keith Goddard and Channing Smith’s article, Implications of the Current Shiller P/E Ratio, which appeared March 16:
Dear Editor,
Keith Goddard in both his February article and the more current version on the predictive value of the Shiller P/E 10 offers some very useful data analysis. As many people have argued (Yves Smith most recently in her excellent book "Econned"), the Efficient Market Hypothesis (EMH) is based on assumptions that are inherently not true - specifically that people always act rationally and they have perfect information. As Paul Samuelson said, Eugene Fama's theory was incredibly important, if of little practical application.
What has been bothering me in the context of Goddard's article is his, and by extension the profession's, use of the word "random." Burton Malkiel who first coined the random walk hypothesis only meant, I believe, to say that tomorrow's prices cannot be predicted by today's prices. In other words, market action is not serially correlated on a day-to-day basis. Nothing in the data presented by Goddard refutes this. No one disputes that over the longer term, the capital markets of the industrialized world have trended higher, even when adjusted for inflation. Thus the longer-term outcome is not presumed in any model to be the result of a 50-50 coin flip, or a zero-sum game. What is presumed is that no one can predictably outperform the market's expected return on a consistent basis.
Markets in the short term may or may not be a random walk. It would take a different and far deeper statistical analysis to refute that point than is presented here. However, Goddard does add to the pile of evidence that EMH, specifically the part that there is no information that can give one a "leg up" on investing, is not descriptive of real markets at work. Whether the apparent competitive advantage provided by what we might call "new" information contained in the Shiller analysis now gets arbitraged away as investors absorb this lesson remains to be seen. EMH adherents would argue that this is the inevitable outcome.
Sincerely,
Martin Weil
MW Investment Strategy
Healdsburg, CA
