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Malkiel’s Mendacity

As I’ve developed an understanding of the macroecon and finance world I find the same disturbing trends across both fields – a highly politicized school of thought has dominated much of the thinking.

Regular readers probably know my views on mainstream economics, but I find many of the same problems muddying the waters in finance.  For instance, concepts like the Efficient Market Hypothesis and Rational Expectations are essentially conservative ideas constructed in a manner to establish an empirical argument against forms of government intervention.  They essentially say “markets do things better than governments so stay out”.  There’s a lot of truth to ideas like this, but they dominate the discussion to the point where they’ve become extremely counterproductive.  And yet people win Nobel Prizes for these ideas and the underpinnings of Modern Finance rest largely on this kind of biased thinking (no wonder they reject behavioral finance given how biased most of these economists are!).

I was reminded of this as I read this blog post by Burton Malkiel who scolds stock pickers for their performance in 2014. For instance, Malkiel, the father of Random Walk and a proponent of the Efficient Market Hypothesis, says you shouldn’t try to predict the future returns of assets because the markets are basically too efficient to outguess them.  That is, of course, unless he feels like predicting the returns of asset classes like he did before 2014 when he told people to avoid long-term US government bonds, the very best performing asset class so far in 2014 (zero coupon bonds are up an amazing 27.5% this year and 30 year bonds are up 17%+):

“Governments wrestling with large budget deficits, huge unfunded liabilities for entitlement programs, and high unemployment rates have adopted policies of keeping interest rates extraordinarily low.

Ten-year U.S. Treasury bonds yielding 3% provide neither generous returns nor an adequate margin of safety to make a shift from equities to high-quality bonds an unambiguous risk-reducing strategy.”

I remember the article vividly because it jumped out at me as being so obviously hypocritical and erroneous.  What’s ironic here is that Malkiel is not only picking assets specifically (something his own theories say you shouldn’t try to do), but he’s making what is obviously an erroneous political argument.  The US government is not at risk of some type of Grecian moment because of “unfunded liabilities”.  The US government is not going bankrupt yet he paints the government’s debt situation as something dire that warrants an underweighting in the asset class.  Malkiel is basically saying he knows more than the markets do so you should listen to him and underweight US government bonds. Malkiel might not like all this government debt, but it should have NOTHING to do with his theories on finance.  But he is clearly just making a political argument masquerading as financial analysis.  Sadly, that’s what much of modern finance and modern economics is – just politics masquerading as science.

This is important stuff.  And if I am right then the future landscape of modern finance and mainstream economics will look very different than it does today because lots of people are going to realize that the underpinnings of the current thinking aren’t just a little bit wrong, but very wrong.


  1. Frederick

    It’s fun watching you connect the dots between the finance and econ sides of all these discussions.

  2. Mark Caplan

    If Malkiel’s prediction on bonds proved right, he’d be a hero. If his prediction proved wrong, that would just add to the evidence and prestige of his efficient market theory.

  3. John Daschbach

    His comments seems to be straight out of the Koch funded political movement. But any college level economics student understands that “Unfunded Liabilities” are a myth. Add to that the view that the government is able to set long interest rates. In fact, it’s both amazing and terribly sad that people say these type of things when they have argued the opposite in their past work. In an efficient market the market sets prices and the government just goes along for the ride.

  4. The Other Matt

    Maybe it’s just my politics, but Cullen I think your post today is one of your most insightful and honest. Obviously politics has always played a role in economics and finance, but the status quo has, perhaps for no other reason than self-preservation, taken it too far this time.

    Please keep beating the drum of common sense and awareness as to how economics work in the real world — I have a sense, and frankly the optimism, that you and the millennial generation will be the ones to clean it up and put a lot of tired ideas out to pasture once and for all.

  5. Frederick

    Cullen, I was wondering – isn’t Malkiel just a factor investor? These guys using Fama French models seem to think that there are just a few drivers of stocks, but then they cherry pick which components of those factors you should focus on. As you noted, that just looks like “asset picking” as opposed to “stock picking”. How has this hypocrisy persisted in finance for so long without being called out as contradictory?

  6. jswede

    “the very best performing asset class so far in 2014 (zero duration bonds are up an amazing 27.5% this year and 30 year bonds are up 17%+)”

    Zero COUPON bonds I assume he means…. ~24yr UST strips (zero cpn) due 2/38 are up 27.5% this year. the 30yr (due 11/43) strip is up 36%.

    My vehicle for max duration UST is TMF, which is up 60% on the year. Sadly, I was early and am only up ~40% since about 12 months ago.

  7. Herbert Moore

    “You can believe your strategy works because you’re taking extra risk or because others make mistakes, but if it deviates from cap weighting, you don’t get to call it “passive” and, in turn, disparage “active” investing. This peeve may be about form over substance—marketing versus reality—but these things count.”

    From “My Top 10 Peeves” by Clifford S. Asness,

  8. Cullen Roche

    Of course Asness has covered all of this. It’s no wonder that an advocate of risk parity has been riding the bond bull market to riches all these years….He gets this stuff. He’s a pseudo EMH guy. Maybe a bit more so than I am, but I have a feeling we’d agree on most of this stuff.

  9. Cowpoke

    Market Mendacity is more like it.

    This market today has the Exact same feel as the dot com bubble.

    All the hip newbies to the scene touting this site or that site, this concept or that.. Billion dollar valuations for ^^$^$&^$^$#@@@&.COM
    There is a a lot of psudo money sloshing around out there distorting true value.
    Buyer beware

  10. blonderealist

    Did you see Malkiel’s opinion piece (“Are Stock Prices Headed for a Fall?”) in today’s (8-28) WSJ? He confidently states that the CAPE does a “reasonably good job of predicting 10-year equity returns.” Seems that the CAPE ratio is currently above 25, above its long term average of around 15. Then he predicts we’re facing a low return environment for some time. He likes emerging markets — they have a low CAPE ratio. Then he goes on to recommend tax-exempt bonds, especially the closed-end fund versions with moderate leverage.
    I can’t say that I learned anything new from the piece — it was pretty basic and mostly very old news. The revised 11th edition of his “A Random Walk Down Wall Street” wlll be out later this year. He probably has friends at the WSJ who don’t mind helping him promote his new book.

  11. Cullen Roche

    He’s such a hypocrite! This is a man who made his reputation entirely on the idea that you should just buy the market because the future is random and the market is impossible to beat. And yet here he is constantly making forecasts about future returns and explicitly recommending specific assets.

    How can such a high profile person get away with such a blatantly contradictory commentary????

  12. Frederick

    Cullen, if the financial assets of the world are dynamic then that means we need to be dynamic as well. There really is no such thing as a “passive” investor even in the purest sense of the word. But how dynamic should we be in your opinion? Does that mean we should change portfolios up every year, every quarter, once a cycle, once a decade? Thanks in advance.

    PS – Your recent work on this has been totally brilliant. It’s really opening my eyes up to a new way of thinking. I used to be very active, then went totally passive and now I am scared that I am not being dynamic at all and fear what could happen in a market decline. Thanks for any help.

  13. Cullen Roche

    There’s really no way to answer that question for you. It would be imprudent for me to give some specific advice without knowing much more about your specific situation. Some people need to be very dynamic. Some people need to be less dynamic. You can’t really generalize about this stuff.

  14. Cullen Roche

    When someone misunderstands an operational reality of the monetary system it doesn’t mean the market is efficient! It’s just evidence that he doesn’t understand the monetary system. I have been saying, for years, that the USA did not have to worry about higher interest rates because of “unfunded liabilities” and high debt levels. Anyone who knows how the US monetary system works knows that solvency and bond vigilantes are nothing to worry about. Malkiel proves that he just doesn’t understand what he’s talking about. That’s all.

  15. Frederick

    It’s worse than that. Malkiel’s misunderstanding actually proves that the market isn’t efficient. If the most informed investors are pricing in the wrong information then EMH has to be wrong at least to some degree.

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