Stocks soaring for senators: are members of congress enjoying the benefits of insider trading at the expense of taxpayers?

AuthorZiobrowski, Alan
PositionEconomics

"SENATORS' STOCKS beat the market by 12%" blared a headline in the Financial Times. So what? Isn't beating the market what everyone tries to do? That is the main reason most people read the Financial Times in the first place. We hire stockbrokers, listen to the experts on CNNfn, watch "Wall Street Week" on PBS, and buy books that teach us how to pick stocks because we all are trying to beat the market. When choosing a mutual fund, we are looking for portfolio managers that will do better than the average. Shouldn't senators be able to hire the very best financial advisors available?

Logically speaking, the argument that experts should be able to predict which stocks will be winners or losers is profoundly seductive. It is deceptively obvious that money managers, who study the ups and downs of the market, examine the balance sheets of companies in minute detail, follow the latest innovations in products and technology, and use all the other sophisticated tools and techniques at their disposal, should be in the best position possible to forecast future stock prices. Alas, like so many other no-brainers, this one is blatantly false.

For decades, academics have known that it virtually is impossible to beat the market. This is referred to as the efficient market hypothesis, which contends that, if a person is using publicly available information only, that individual is highly unlikely to beat the market by a significant amount. Public information is anything you, your broker, or your portfolio manager normally have access to, including corporate financial statements, publications such as The Wall Street Journal and Baron's, whatever you see on TV, everything available on the Internet, all the books in the library, and whatever else is in the public domain. You might be especially lucky (or unlucky) for brief periods of time in much the same way as you might get lucky for one night at a blackjack table. Over the long haul, though, you likely will be very close to the market average.

The key to comprehending the efficient market hypothesis is understanding the difference between a great company and a great stock. Suppose your broker calls you about a great company. The firm has a strong balance sheet, brilliant management team, and a fabulous product, which is poised to take off in the next 12 months. He wants you to buy the stock. Let us suppose the broker is right on target. This undoubtedly is an outstanding company, but is it an outstanding...

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