(or at least the work of the Invisible Hand), why are there these monstrous bubbles, crashes, and so forth?
For reasons that will be familiar by now, value investors are not remotely up to the task of keeping the market prices of $10 trillion or more of stocks in line with intrinsic values. Let me briefly summarize:
not only do value investors account for but a small part of the market, but there are some
almost perverse factors keeping them small. When value investing is in vogue, they are tempted to close a fund (“or two, or three. . .” as First Eagle recently intimated) to new investors, and when they are sorely out of step with the prevailing mood, as happened in the late ‘90s, they seem content to see their pool of assets shrink, rather than abandon their principles.
for stocks that are priced too high, hedge funds may sell short, but mutual funds rarely do.
Instead, many of them sit on their hands, holding a bundle of cash, as some are doing even now.69 Not much help for the market from here.
for stocks that are priced too low – ah, now we’re talking, but only if the market price is at a deep discount to the intrinsic value. This
group is very, very picky. Think of Ted Williams waiting for a pitch he can hit on the sweet spot. When economists speak of arbitraging
price differentials, they are often referring to modest discounts that would not remotely tempt investors who have been disciplined to
buy only when it’s a very fat pitch. It’s that margin of safety.
ultimately, the problem is the snail’s pace of their trading, only about one-sixth that of the average mutual fund. What the economic
model requires is red-blooded activists, and these patient value investors operate on an altogether different tempo.
to be sure, value fund managers need investors who share their investment philosophy and are not distracted by the inevitable tracking
errors or the mind numbing chatter on CNBC. Scholars like to dwell on the fact that the individual investor tends to be an uninformed
trend follower, but an equally intractable problem is the CFO who hires vast numbers of managers and advisers to deflect any potential
criticism of the near-term performance of the corporate pension plans.
Robert Shiller recently suggested that “[f]rom a theoretical point of view, it is far from clear that smart money has the power to drive market prices
to fundamental values.”70 This study reinforces Shiller’s theory.