When I was a student, I received a lot of A’s in economics.  In other words I labored and absorbed the tenets, formulas, and theorems of that stale science.  It bored the daylights out of me, delighted my professors, but I persevered nonetheless.  Most normal people dropped economics like a hot potato for the same reason. They still do. Now when I write about this subject, I try to take some of the boredom out of it by injecting a few crisp words and phrases into my narrative.  I also like to explain issues with easy to understand logic and examples; and I rely on persuasion in the belief it is more likely to keep readers awake than not.  These elements of style disqualify most of my discourses from inclusion in the “scholarly” journals.  Apparently, the keepers of those journals are stricken by panic attacks when they come upon anything that is actually readable.  Other economists write to fill a “curriculum vitae” with a long list of publications that nobody reads except for other economists looking to fill a teaching position with someone just like them.  Beyond that, economists keep their ideas about how to fix a wayward economy to themselves out of fear (presumably) from offending someone and thus putting their income and lifestyle in jeopardy.  Meanwhile, millions of residents suffer from an economy that is in a deplorable state of mismanagement.  Even as conservative and progressive politicians point their fingers at each other, and a recession sinks deeper and deeper, economists disappear into the woodwork in droves.  

What a boringly safe way to live!  I wonder how many economists ever wrote a love poem? (I posit that question as a rhetorical query to keep your interest in case you are beginning to nod off).  Can you picture an economist sitting around a Bar-B-Q pit, late at night, in a small village in Thailand, with smiling locals, drinking oriental beer, while teaching them the words and melodies to a few old America standard songs?  I have done both.  And I had a great time!   

I was once rejected for a teaching position at a mid-sized university that I kind of wanted.  My feelings were only temporarily hurt when I remembered Groucho Marx’s rejoinder:  “I would never join any organization that would have me as a member!”  Now that is the attitude of a free spirit!  Of course, Groucho had a set of back-up qualities that I lacked:  He was funny, witty, and charming—three attributes that also are never found near the economics department at any university.  But I digress. 

How often do you get the chance to destroy a school of thought known for its scholars and Nobel Prize winners?  Well, I didn’t exactly destroy one, but I left a heel print on their turf they will not soon forget.  

Long ago I ventured into the world of investments, and set about learning all about it—first by trial and error—and then by applying a few of the tools of science to the task.  I made some headway until I ran up against the rules and wisdom known as the “Chicago school of thought.”  This school is associated most notably by its association with Milton Friedman, someone I have always admired, not only for his sharp mind, but also for his wit.  Conservatives loved him because of his penchant for assuming he was right about--everything.  I disliked that part of him for the same reason. 

The Chicago school was (and still is) known for putting forward the “efficient markets hypothesis” and the “random walk” theory.  The efficient markets hypothesis asserts that everything that is known or is expected about the price of a stock is discounted in its present price.  With millions of eyes and minds examining a stock, while bidding the price up and down, there is nothing left to be discovered about it.  Therefore, there is nothing that you or I can discover about a stock that has not already been discounted in its price.  It is utterly hopeless to try.  A stock’s price is subject only to future events that nobody can possible know.  Indeed, it’s price moves randomly up or down much like someone taking a random walk down the street.  As a consequence, nobody can “beat the market.”  The best you can do is buy the market, at lowest cost, and hold it for the long pull. This “strategy” will outperform every other technique known to man or beast.  

With this wisdom in hand, the Vanguard and the Dimensional Group of mutual funds were founded.  Both groups quickly acquired noted professors from the Chicago school who lent their impeccable credentials to the ventures.  Today these funds manage $4.7 trillion in assets.  That’s a nice number from which to draw down a handsome salary for quite a few eggheads.  And all they have to do is make their mutual funds look as close like the market they are in, and leave all the low-level paper work to low-paid clerical staff.  And, of course, they must expend substantial advertising dollars in telling the investing public how smart they think they are.  

Well, I had to admit they had a good argument going for them.  But I was not convinced it was true .  So I set out for find out for myself.  

First, I acquired a very old copy of Burton Malkiel’s book “A Random Walk Down Wall Street. It was one of its early editions (now in its 13^thprinting).  Malkiel was a professor of finance at Princeton (later an advisor to Vanguard) who used students to prove that he could duplicate every stock market movement by simply tossing coins.  Presumably they sat around in groups tossing heads and tails till the cows came home, while managing to duplicate M’s and W’s and Head &Shoulders formations, as well as a host of others.  

Two issues came to mind:  First, students tend to give their professor whatever he wants, as long as they get an A, or at least extra credit.  And how long does any normal kid with excessive hormones surging through his body want to sit around tossing coins?  They probably took a lot of short cuts, or lied. 

I quickly duplicated his years of logging in heads and tails in a few minutes with a random number generator.  Still, he was pretty much correct.  I could also duplicate a lot of patterns that many stock followers relied on in making judgments about what was coming next.  

But then along came a flash of inspiration.  I had a copy of a simple nonparametric test for randomness call the “Wald-Wolfowitz Runs Test.”  I took the longest series from the daily price closings of SP500 going back about 50 years.  Then I took first differences to eliminate the trends, and converted the results into binary format.  That gave me the ups and downs from each day in a runs format.  (A run is the distance between changes of consecutive ups or downs in a sequence).  I then tested to see if the number of runs were within the probability of what would be expected if the series were random.  

And the answer was:  No way.  The runs were not random.  There were considerably more positive runs than negative, and the probability was less than one chance in a thousand that this outcome was the result of random factors.  Moreover, the average value of the positive runs was considerably higher than were the negative runs.  I repeated the test about 50 times, with the same results.  

These results told me two things:  Stock price movements were not random, and there were excess profits to be had if a good investigator wanted to dig for them. 

I published my results in a relatively obscure investment journal.  Shortly after the journal came out, I received two phone calls—both from professors of finance.  One was from the University of Chicago.  He sounded like he was trying to disguise his voice as he sought detailed information about the software and how to use it.  I was more interested in getting him to promise to Xerox my paper and distribute it liberally in the economics and finance departments on his hallowed turf.  And to be certain that Prof. X gets three copies!  

Soon afterward, I sent copies to the Vanguard Group.  They completely ignored me (while probably burning my copies at a quiet midnight ritual). 

Long ago I discovered how to capture those excess profits that one Nobel Prize winner continues to say is illusory.   Being a maverick doesn’t pay well, but sometimes it is pure fun.