"One of the Most Ridiculous Ideas Ever Recorded" -- Debunking Wall Street's Fuzzy Logic

One of Wall Street’s most storied careers began with a job ad. 

Having emigrated from Belgium as a boy, a young Jack Schwager worked his way through Brooklyn College, and enrolled in graduate studies at Brown University’s economics department. After earning his Masters Degree in 1971, Schwager placed a job-seeking ad in the New York Times. 

“Back in those times, you could post a position-wanted ad,” he recalls. 

His ad had fifteen respondents. Fourteen were scams and pyramid schemes -- positions typical of firms that would prey on naive job-seekers in that era. 

But one respondent was a recruiter for a research position at the futures department of Reynolds Securities. The job application required a ten-page report on copper futures. Schwager said, “Years later, I was going through some old papers and I found it. It was actually pretty good – you couldn’t tell I never worked in the industry.”

Finance & Fallacies

Now, more than forty years later, Jack Schwager is an authority on hedge funds and futures. He is most renowned for his best-selling series of books, Market Wizards, in which he interviews the world’s most prominent traders — including Ray Dalio, Bruce Kovner, Michael Steinhardt, and Joel Greenblatt. He is also a portfolio manager for a fund of managed accounts recently launched by ADMIS, and he spent more than two decades directing futures research at some of Wall Street’s biggest firms. 

Benzinga spoke to Schwager as he promotes his latest book, Market Sense and Nonsense.  “It’s a compendium of everything I’ve learned in my career about what people misunderstand about how markets really work—everyone from ordinary investors to professionals to traders to academics.”

Essentially, the book is about the fallacies that plague investor behavior. 

Past Performance & Future Results

One example is the widespread assumption that investments that were effective in the past will likely continue to be profitable in the future. Schwager cited the bond market.

“Bonds have been on a bull market for the last 30 years. They’ve gone from 15 percent to 3 percent. They’re obviously not going to go from 3 percent to negative 12 percent – so there’s no way that the past can be representative.”

Irrational Market

Schwager’s book also challenges the widespread notion of the efficient market hypothesis—the notion that the marketplace is always right.

“That is one of the most ridiculous ideas ever recorded. It is an idea that can only be favored by someone who has never allowed himself to be persuaded by the facts. There are so many examples where market prices are screamingly wrong.”
Schwager pointed to an instance when, in 2000, the handheld device company Palm spun off from parent company 3Com in an IPO. “3Com was convertible to multiple shares of Palm but was actually selling at a discount, which effectively meant that 3Com was trading at a large negative price. You could have bought 3Com and had more Palm shares—and the rest of the company.”

Toxic Incentives

Why is there so much faulty thinking when Wall Street is full of brilliant thinkers and Ivy League pedigrees?

“Everything runs on incentives.  If you’re running a pension fund, could you see yourself allocating to a strategy that’s done poorly?  If you’re right, maybe you’ll get a pat on the back.  But if you’re wrong, people will ask ‘what kind of idiot are you?’”

He continued, “Whereas, if you do what everybody does, you’re safe.  In most places in the investment world, if you don’t stray too far from the conventional wisdom, your job will be secure.  If you really do some of the things I’m suggesting, you’re going to stick out like a sore thumb.  And even if you’re right, there are periods of time where that approach will be worse than the conventional stuff—and you’ll be out of a job.”