By Brett Arends
If anyone ever doubted that the Nobel Prize for Economics was a farce, Monday's announcement of the latest winners should put the matter to rest.
To honor their contributions to the understanding of markets and asset prices, the Nobel committee has awarded prizes to three American economists.
One is the University of Chicago's Eugene Fama, who says the stock market is rational. The other is Yale's Robert Shiller, who basically (I exaggerate) says it isn't. (The third prize went to Fama's Chicago colleague Lars Peter Hansen, an econometrician).
Fama questions whether "bubbles" exist. Shiller says they are common, and easy to see. Fama said U.S. house prices weren't in a bubble in 2006, even in retrospect. Shiller warned that they were--even before the crash. (He also correctly warned of a stock-market bubble in the late 1990s).
Fama thinks you should never try to time the market, because future returns are completely unpredictable and stocks will follow a "random walk."
Shiller says that for most of the past century or more you could have timed the market quite easily. All you really had to do was to invest in the stock market when stocks were cheap (when measured against the previous 10 years' earnings).
People who did that usually earned excellent returns over the next 10 years, he found. Meanwhile, those who invested when the stock market was expensive on this measure usually earned poor returns.
Shiller's analysis, which includes data publicly available on the web, actually offers investors the most credible system which exists for "timing" the market.
In other words, the Nobel committee has awarded its prize to the man best known for saying you can't beat the market, and at the same time to the man best known for saying you can.
I have a simple question for the Nobel committee.
Are you kidding?
Joan Robinson should have lived to see this. The late, great economist from Cambridge, England, was rebuffed by the Nobel committee in the mid-1970s, when she was widely expected to win the prize. Some blamed simple sexism. Others said the rebuff was political--Robinson had migrated to support certain dictators, like Chairman Mao.
But oddly enough, Robinson never minded.
My dear friend Stephen Rousseas, a distinguished economist and the former chair of economics at Vassar College, once gave me a typewritten piece of paper containing some remarks Robinson had made at a talk in the mid-1970s. She said the Nobel Prize for economics shouldn't even exist. It was a joke. Economics, she said, is not a natural science like physics or chemistry. (It's a social study.)
So, as she noted, one year the Nobel committee would give the prize to a liberal economist like James Tobin, and at other times to a conservative economist like Milton Friedman.
Imagine, she said, the Nobel committee giving the physics prize one year to a physicist who says the Earth is round, and then giving it next year to one who says the Earth is flat.
It's a farce. By definition, they cannot both be right.
Rousseas, sadly, died almost two years ago. He would have loved this. His contempt for the University of Chicago's neoconservative school of economics knew few limits. Watching Fama get a prize at the same time as the man who had best disproved his main theory would have had him in fits of laughter.
Today's Nobel committee announcement tries to weasel its way around this contradiction by saying, in essence, that Fama's model works in the short term and Shiller's view is more accurate in the long term. But I suspect the decision is a compromise between two factions. The "rationalist" view espoused by Fama and Kenneth French dominated American finance for decades. Today it is looking threadbare.
Look at the Standard & Poor's 500 over the past 20 years. Look at emerging markets. Look at gold, silver, bonds, housing, Las Vegas condos and islands in Dubai. Do markets really look rational to you? Are prices "efficient"? Are bubbles rare or nonexistent or hard to see? Seriously?
The rationalist view doesn't even make sense intellectually. Lynn Stout, a law professor at Cornell, has eviscerated its underpinnings. Financier Robert Haugen, who died early this year, had shown that in many ways the theory was upside down. He found that you could have earned higher returns than the market over time, with lower risk, by investing in bigger, safer, blue-chip value stocks.
Fama and French themselves admitted in the mid-1990s that the market wasn't perfectly rational after all: Small stocks tended to outperform larger ones, and cheaper "value" stocks tended to outperform more expensive "growth" stocks, they found. This was true even when you adjusted for risk, so it didn't fit their theory at all. Their response? A new "three factor" model which makes no sense at all.
Chances are your money manager is still following the Fama-French rationalist school of finance when it comes to investing your money. Hence all those allocations to "small cap value," "large cap growth," "midcap blend" and so forth.
I have long suspected it's all hooey--pseudoscience and marketing shtick. Apparently the Nobel committee agrees and disagrees at the same time. How absurd.
-Brett Arends; 415-439-6400; AskNewswires@dowjones.com
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10-15-13 0825ETCopyright (c) 2013 Dow Jones & Company, Inc.