Financial Industry Rants & Sins, Vol 31

During the 2004 general election campaign for president, John Kerry was called out on several occasions for “flip-flopping” on his positions on several issues. Most notoriously, he said that he was for the war in Iraq before he was against it. I even remember seeing pairs of flip-flops being sold with his picture on them.

When it comes to financial commentary and advice, one of my biggest pet peeves is an advisory that says something, and in the same breath, utter the complete opposite, or at least an opposing opinion.

Don’t get me wrong, there are times that this is appropriate. For example, if the advisor says, “There are three distinct possibilities that we can expect to happen….” Then I expect the advisor to offer the three variations of what to look for.

However, what I heard this week is something we need to look out for. It’s a situation where the advisor says to expect something to happen, and then says not to expect it under the very same circumstances.

Here is what he said on his radio program: “No one has a crystal ball and we have no idea what is going happen in the future.”

That seems pretty benign, and regarding stocks, bonds, real estate, or any other asset you may purchase, it’s a pretty safe bet that no one knows what will happen next.

Then the cohost asked him, “Ryan, what do you think the stock market will do tomorrow? Will it go up or down?

He replied, “The prices we see in the markets have all future events already priced in.”

No, actually markets don’t have all future events already priced in. You already admitted that no one knows the future. We don’t know if tensions on the Korean peninsula will escalate, because if we did, we would know exactly which defense contractors will be called upon for more equipment, we would know exactly how much demand there would be for safe haven assets like gold. Heck, we would even know which soldiers will come home alive and well to their families.

But we don’t know the future. We only know the past. Financial markets are the same. In financial markets we can look at the financial statements of companies whose stock trades on the exchange, or companies who offer bonds to investors. We know which CEO is getting ready to step down, and we know how much debt the Metropolitan Transportation Authority is due to pay in full by next September.

Yet it’s impossible to know which companies will do better than we think, which will do worse, and which will stay about the same. We don’t know who is going to declare bankruptcy. With all of these we can make an educated guess at best.

What this advisor is relying upon to make his dichotomous statement is 1) no one really knows the future, and 2) something called Efficient Market Theory (EMT), Or Efficient Market Hypothesis (EMH). It’s just two names for the same thing.

EMT states that the stock market has already taken into consideration all available information, and therefore, the price you pay for any share of any company has been fairly priced at the most efficient market rate.

That means that if you buy shares of Pretium Resources at $11.04 per share, it’s impossible that they were actually worth $11.05 or more, or $11.03 or less, at the time you made the purchase.

The fallacy of the advisor is that when you bought the shares for $11.04, he thinks the future is priced in. Meaning, he thinks we know exactly when Pretium will commence a drilling program at their Snowfield project, what the results of the drilling will be, how much it will cost to build a mine, how many ounces of gold will be mined each year, and the price the gold will all be sold at.

We actually don’t know the future. We only know what Pretium has done until now. Even though the management team at Pretium has given us a general outline for their plans with the Snowfield project, the exact outcome is unknown.

Remember that the stock and bond markets are non-prophet organizations!

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