Markets: Stupid or Smart?

For the past decade, I have been grappling with an issue that I have been on both sides. Are markets giant social computers tallying info and providing the best reflection of all that information? Or are they chaotic and stupid and easily manipulated and gamed to one's advantage? In short, are markets stupid or smart?

People like Warren Buffett, George Soros, or Taleb will tell you that markets are stupid. All three have a healthy distrust of markets. In the case of Taleb, he says that markets are not good at pricing black swans which are rare events.

On the flip side, we have the efficient market people such as the libertarians and economists like Eugene Fama or Burton Malkiel who stress the efficiency of the markets and how they can't be beaten. Clearly, statistics indicate that there are efficiencies to the market over the long term. If this weren't so, Warren Buffett wouldn't be where he is now.

From a personal viewpoint, I can tell you that I saw both the dot-com bubble and the housing bubble. But I knew of no way to profit from that knowledge that didn't involve huge risks based on timing. I believe in bubbles which seem to indicate that markets are not efficient. Similarly, extreme pessimism or "anti-bubbles" also occur. Ben Graham's Mister Market analogy seems to fit here.

I tend to think there is a weakness to the rational actor model of economics as espoused by the Chicago School. It is an abstraction that helps in calculation but breaks down in the real world. This is the essential message of Taleb but also the Austrian school of economics and the behavioral finance people.

My bottom line is that markets are not stupid or smart but like an eccentric genius that is confounding you at every step of the way. I disagree with people who think economics can be managed, and I also disagree with people who think the market can be whipped. The market makes idiots of everyone, and I think even Taleb is exposed to the Black Swan of government default on its debts. What I can say is that the market rewards the patient and the disciplined and the humble. The market also punishes the proud. I think your estimation of the market is a direct reflection of your own hubris. For me, I think the market is brilliant.

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