The late John Bogle was the founder of The Vanguard Group and the creator of the world’s first index fund. In this June 2016Â interview, he discussed his views on market efficiency and market timing.
Market efficiency
Many passive investors believe strongly in efficient market theory - the idea that markets always accurately incorporate all available information about a given security, so the price of said security is always equal to its intrinsic value. In other words, it is the opposite of value investing, which relies on the idea that assets can be mispriced. But what did the father of passive investing think?
“It’s funny, because they gave the Nobel Prize to some of these people this year, the people who believe in efficient market theory. When I started the first index fund, I had never heard of the efficient market hypothesis, and I didn’t think it worked. What we know after all of this experience is that the market is efficient sometimes, and inefficient sometimes. It’s inevitable. And it’s very difficult to have the wisdom to know the difference. I don’t have that - although I know a little bit about valuations.”
Bogle’s point was that his method for predicting market returns has been quite accurate and does not rely on the efficient market hypothesis.
“Corporate returns come from dividend yields and earnings growth and changes in price-earnings. You know the dividend yield when you look at the market today. You know what the long-term earnings growth is - probably five to six percent in the U.S., and if price-earnings multiples are over 20 the odds are probably 80% that they’ll be lower at the end of the decade, and if they’re under 12 the odds are about 80% they’ll be higher at the end. But this doesn’t happen in a vacuum. I think that efficient market theories go too far and have absolutely nothing to do with me creating the first index fund.”
Market timing
Bogle believed that even though anyone can theoretically be a great market timer, the odds of that happening to any given person are exceptionally low. Therefore, individuals should not try to do so:
“I suppose anyone can [time the market], but investors as a group by definition cannot. They can’t all get out at the top and in at the bottom. Please understand that if you’re getting out of the market at the hot top, somebody else is getting into the market at the top. You’re selling your stocks - somebody else is buying them. So it’s just not a good idea.”
He also believed the era when security analysts could pick out value stocks and accurately time the market has long passed:
“Security analysts were valuable when they were doing it by themselves and they could pick out good values, but when everybody has security analysts all over the place, competition equalizes. There’s a certain amount of efficiency built into that - not perfect, but pretty good”.
This ties into the previous idea concerning market efficiency. My personal view on this is that although the ubiquity and availability of information has made value opportunities more difficult to locate, the proliferation of trend-following algorithmic trading systems has created new opportunities to benefit from mispricing. Automated systems are great at executing large orders at high speeds, but they are not very discerning. In my opinion, the next generation of value investors should look to exploit new sources of market inefficiency, rather than relying on older playbooks.
Read more here:
- Howard Marks: Everything Is Cyclical
- The Rise of the Living Dead
- Warren Buffett: Derivatives Are Dangerous
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