INVESTING: Time to ditch widely touted-but wrong-investing rules

We love a good conspiracy in America. The FBI just spent millions of dollars looking for Jimmy Hoffa again, and again came up empty.

We’ll be talking about who killed JFK until our grandkids are gone. Today, I am going to start a new one, and when you read this you are going to want your finance professor’s head on a platter.

There is a conspiracy to keep you from making money. I can’t pinpoint the exact beginning of the plot, and I don’t think it was intentional. But this theory is far-reaching and it is powerfully embedded in our entire financial structure. It has been going on so long that just about every major person of influence buys into it.

The stock market never has been an easy place to make a lot of money over a long period. This is why people like Warren Buffett are so revered. Because of the difficulty, many years ago academics came up with a phrase I’m sure you are familiar with: “You can’t time the market.” (Yes, you can, but that is a different story.)

The broker-dealers grabbed this and pushed it mainstream, because as long as they couldn’t figure out how to time the market, you shouldn’t, either.

Besides, if you sell the stocks they told you to buy, how does that make them look? With this nugget in hand, a few professors at the University of Chicago developed intricate and well-thought-out (but still wrong) ideas called “the efficient market” and “modern portfolio theory.” These ideas became so popular that they are the standard for how trillions of dollars of investment decisions are made every day.

Advocates of efficient-market theory say you can’t time the market, a belief resting on three very shaky premises. The first is that everyone in the world involved in the markets has access to the exact same information at the exact same time. This is so full of holes that it barely registers, but do you really think I have the same information about Eli Lilly and Co. that CEO Sidney Taurel does?

Ridiculous, but it gets better. The second premise is that we will all interpret the information the same. Lilly announces a cure for death. I think that’s great because I love people, so I buy the stock. You feel it’s terrible because you are an environmentalist, and you go into an Al Gore-inspired rage as you realize the Earth can’t sustain a population that eventually would top 50 billion.

We definitely drew different interpretations. The third and most outrageous premise is that we will act rationally with this information. People are emotional, not logical. We always have and always will drive markets way too high and much too low.

Another major belief that has been foisted on us is that company earnings drive the market. The most amazing thing about this myth is how universally it is believed, with virtually zero challenges to its merits.

Doesn’t anyone ever think to raise his hand and ask for proof? I did, and the evidence is startling. In the three major stock market tops of 1929, 1973 and 2000, the market peaked and began declining an average of six months before the top in earnings.

WorldCom’s earnings didn’t start dropping until the stock was down from $65 to $15 almost two years later! Its investor expectations and emotions that move stocks.