Well, you probably think the silly season has set in with a vengeance when you read that. But in an article in the FT on Thursday, and in testimony to the Treasury Select Committee in April, that is what Professor Roger Farmer from Colombia recommends. Since, as Keynes reminds us, “madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”, perhaps Professor Farmer’s idea should be investigated.
He bases his recommendation on “The Inefficient [Financial] Markets Hypothesis”, the title of an NBER Working Paper authored by Farmer and his colleagues Nourri and Venditti (you can buy for $5 from http://www.nber.org/papers/w18647, or just read the abstract). This shows that, when you introduce “real life” assumptions like population change and differing discount rates among individual investors, however rational individual investors may be, markets are not rational, or, in the jargon, Pareto efficient. Hence the possibility that government intervention could make some investors better off without necessarily making others worse off.
Now, it has to be said that a financial economist proving that stock markets are not rational or efficient may not come as a great surprise to investors, those in the financial services industry, or even the man on the Clapham Omnibus. Let’s take just one recent example: Bernanke says Quantitative Easing (QE) will wind down as the US recovers – and global markets drop like a stone. Carney, in the UK, says QE will be replaced by more market guidance – surely a stronger move, as it’s unconditional – and the UK stock market goes up 1%. Rhyme or reason ?- difficult to see.
But back to the issue in hand – could governments set up some kind of sovereign wealth fund to “lean into the wind”, buy stocks when they are “unrealistically low” and sell them when they are “unrealistically high”? I rather doubt. To move markets, the fund would have to be “big”, probably “very big” – and with a known strategy, hedge funds and everyone else could trade against it. While Farmer gives the example of the success of central bank inflation targeting, a better example (and a more humbling one) would be central banks’ efforts to defend fixed exchange rate parities – frequently unsuccessful, and frequently very costly, because they give other market traders the famous “one-way bet” – the exchange rate may fall [if intervention doesn’t work] but it certainly won’t rise. And there are a multitude of governance issues – when to intervene, how to recruit quality staff, etc.
But even if a sovereign wealth fund poses difficulties, Farmer’s work raises another question – why aren’t there more “contrarian investors” who see through the inefficiency of markets and trade profitably as a result. Of course, there are some – I recall a colleague proudly announcing, as bank shares collapsed in 2008, that he’d bought a few and that should see his kids through university. I’m sure at current valuations his plan is on track. But more generally, there do not seem to be “enough” funds with “the long view” willing to make these kinds of bets. Our market structures do not help – annual performance reviews against benchmarks for investment mandates, and the decline of with profits funds for example, pressure many fund managers to not step out of line. So perhaps an investigation as to why we don’t have more contrarian investors, and whether rules and regulations could be tweaked to encourage them, might be a better (if less sexy) outcome to the work of Farmer and his colleagues than governments setting up sovereign wealth funds.
“No rest for the wicked”, as my (Catholic) grandfather used to say – or as the latest evidence from the famous LBS stable of Elroy Dimson, Paul Marsh & Mike Staunton shows, no rest for those trying to earn a “decent” (5% real?) return from their savings. They foresee a world of virtually zero real rates on “safe” bonds and an equity risk premium of 3 to 3.5% on a “long” (20-30 year) view. This is all set out with impressive academic rigour in the excellent (and free, as far as I can see) Credit Suisse Global Investment Returns Yearbook for 2013 (
gleedsaling 