The New Yorker has John Cassidy’s interview with Richard Thaler, Chicago School economist and co-author (along with Werner F.M. DeBondt) of Further Evidence on Investor Overreaction and Stock Market Seasonality, a paper I like to cite in relation to low P/B quintiles and earnings mean reversion. Thaler is also the “Thaler” in Fuller & Thaler Asset Management, which James Montier identifies in his 2006 research report Painting By Numbers: An Ode To Quant as being a “fairly normal” quantitative fund (as opposed to being “rocket scientist uber-geeks”) with an “admirable track [record] in terms of outperformance.” I diverge from Thaler on a number of issues, but on these two I think he’s right:
On the remnants of efficient markets hypothesis:
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On the remnants of efficient markets hypothesis:
Well, I always stress that there are two components to the theory. One, the market price is always right. Two, there is no free lunch: you can’t beat the market without taking on more risk. The no-free-lunch component is still sturdy, and it was in no way shaken by recent events: in fact, it may have been strengthened. Some people thought that they could make a lot of money without taking more risk, and actually they couldn’t. So either you can’t beat the market, or beating the market is very difficult—everybody agrees with that. My own view is that you can [beat the market] but it is difficult.On stock market bubbles:
The question of whether asset prices get things right is where there is a lot of dispute. Gene [Fama] doesn’t like to talk about that much, but it’s crucial from a policy point of view. We had two enormous bubbles in the last decade, with massive consequences for the allocation of resources.
[Cassidy] When I spoke to Fama, he said he didn’t know what a bubble is—he doesn’t even like the term.And I love this line in relation to the impact of the recent crisis on behavioral economics:
[Thaler] I think we know what a bubble is. It’s not that we can predict bubbles—if we could we would be rich. But we can certainly have a bubble warning system. You can look at things like price-to-earnings ratios, and price-to-rent ratios. These were telling stories, and the story they seemed to be telling was true.
I think it is seen as a watershed, but we have had a lot of watersheds. October 1987 was a watershed. The Internet stock bubble was a watershed. Now we have had another one. What is the old line—that science progresses funeral by funeral? Nobody changes their mind.Science progresses funeral by funeral. Nobody changes their mind. It seems to me it’s not the only discipline that proceeds by funeral.
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