"A Random Walk Down Wall Street" Turns 50, and Our Top Terms of the Year

Episode 116 of the Investopedia Express with Caleb Silver (December 12, 2022)

Welcome back and welcome aboard. Anyone else have whiplash from that hard reversal? U.S. equity markets are coming off a bruising week, with tougher talk from the Fed and more signs of sticky-high inflation. For the week, the Dow lost 2.8%—its worst weekly decline since September. The S&P 500 dropped 3.4% and the Nasdaq fell 4%. The Producer Price Index (PPI) for November came in a little hotter than expected, as wholesale prices keep on rising. Add that to the better-than-expected job gains we saw in November, and it really only equals one thing—the Fed is going to have to stay aggressive with rate hikes because the economy is still too hot.

The FOMC meets this week, and Fed funds futures, according to the CME Group's Fed Watch Tool, show an 80% probability that the committee will hike rates a half a percent, or 50 basis points (bps), this week. That won't surprise anyone, but we will all be watching the Fed's dot plot—the most boring chart in economics, to see where the committee thinks rates should be three to six months from now.

Many investors appear to be positioning themselves for more hawkishness from the central bank, given the heavy outflows from stocks last week. According to data from Refinitiv Lipper, U.S. equity funds recorded withdrawals of $26.6 billion—the biggest weekly outflow since April of 2021. Of that amount, $9.9 billion came out of equity growth funds, and $2.2 billion came from value funds, as selling continued for a third straight week in each segment; $992 million went into U.S. bond funds and 886 million went into taxable bond funds, as big investors are getting more comfortable with three to 5% yields, given the shakiness in stocks, and cash keeps ruling everything around me. Money market funds saw $50 billion in inflows in November, the most since December of 2021.

We talked about Wall Street market forecasts and predictions for the S&P 500 in the next 12 months on the last show. Those forecasts range from the most bearish, of around 3200 from Barclays, to the slightly more bullish from Wells Fargo, at around 4500 for a year-end target. Both imply a rise or fall for the S&P 500 of no more than 10%. But the market strategists at BNP Paribas think the worst is yet to come. The team, led by Greg Boutle, head of U.S. Equity and Derivatives Strategy, are expecting a capitulation event next year—a "throwing in of the towel." The team writes, "This would be a departure from the current bear market regime, which has been characterized by a grind lower in equities, as P/E multiples have contracted."

Boutle's team mined 100 years of stock market crashes to determine what may be headed our way. Discounting the swift bear market of March 2020, when the bear market began, BNP says current market conditions mirror 2002 more than 2020, given the drumbeat around impending recession. That bear market was more than two years long, with a drawdown of 50%, and a 29% peak-to-trough move in the VIX Volatility Index. A typical recession bear market is about one-and-a-half years in length, with a median drawdown of 38% and a median peak in the VIX of 40.5.

Meet Burton Malkiel

Burton Malkiel

The Wall Street Journal

Dr. Burton G. Malkiel, the Chemical Bank Chairman’s Professor of Economics, Emeritus, and Senior Economist at Princeton University, is Wealthfront's Chief Investment Officer (CIO). Dr. Malkiel is the author of the widely-read investment book, A Random Walk Down Wall Street, which helped launch the low-cost investing revolution by encouraging institutional and individual investors to use index funds. Dr. Malkiel, also the author of The Elements of Investing, is one of the country’s leading investor advocates.

Prior to his current role, Mr. Malkiel spent 28 years as a director for The Vanguard Group. Throughout the 1970s and 1980s, Mr. Malkiel served as a member of the Council of Economic Advisors to the U.S President (1975-1977), president of the American Finance Association (1978), and dean of the Yale School of Management (1981-1988).

What's in this Episode?

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At the top of every investor's list of the best books on investing, the stock market, and how Wall Street really works, you're going to find A Random Walk Down Wall Street by Burton Malkiel. First published nearly 50 years ago, A Random Walk has more than withstood the test of time. While the products, services, size, and scale of the investment industry have grown exponentially, the tenants, the lessons, and the advice laid out in this Bible for investors are even stronger and more prescient today than they were in 1973.

Lucky for us, Malkiel continues to update his book and share his wisdom. He's the Chemical Bank Chairman's Professor of Economics, Emeritus, and Senior Economist at Princeton University, and the Chief Investment Officer for Wealthfront, a digital and personal finance investing platform. He is our very special guest this week, on the Investopedia Express. Welcome, Professor. It's a real honor to have you here.

Burton: "Pleasure to be here."

Caleb: "Well, congratulations on 50 years for your terrific book. You worked in the financial services industry at Smith Barney before you left for academia, and then you wrote A Random Walk, effectively pulling back the curtain on Wall Street. What made you want to do that?"

Burton: "Well, I have been interested in the stock market since I was a young kid. I grew up quite poor. I didn't do any investing—I had no money to invest. But I knew the price of General Motors stock about as well as Ted Williams' batting average. I grew up in Boston, so Ted Williams was my hero while I was growing up."

"So I've always been interested, and started my career, as you well suggested, on Wall Street. And basically whatever academic work I have done has been on the stock market. And I've kind-of never left the business world, because, while I have been an academic for most of my life, I serve on a number of investment committees. I have served on probably a couple dozen corporate boards. And so, living in both worlds has worked very well for me."

Caleb: "The book is called A Random Walk, but as you lay out in chapter after chapter, it's not all that random when you look at how the financial services industry has found more and more ways for us to give them our money. Explain how A Random Walk came into your mind as you were writing the book, and how it actually plays out throughout the course of the book."

Burton: "Well, basically, I think of the word 'random' as essentially meaning unpredictable, and unpredictable in the sense that it's really very, very difficult to predict who the great investment managers are going to be. And the problem is, you can't simply take the great investment managers of the past and say that they're going to be the great investment managers in the future. Similarly, you can't look at a pattern of stock prices and say, "X, Y, Z company has a great deal of momentum, and therefore you should go and invest in it," because the momentum can end in a heartbeat."

"The idea of a random walk is that you can't predict it. You couldn't say that Warren Buffett was going to be a great investment manager, just as you couldn't say that Cathie Wood, who absolutely shot the lights out in 2000, was going to continue in 2021 and 2022. And you can't say that because a stock went up in 2022, it's going to go up in 2023. That's what I mean by random. Essentially, what people need to understand is that a lot of what happens in the market, particularly over the shorter term, is essentially unpredictable."

Caleb: "The focus of the first part of the book is on bubbles, and there is so much to learn there. When you read about tulip mania, the electronics bubbles, and a lot of the ones that have followed generation after generation, you can't help but think about some of the bubbles that we've been through. But let's just talk about tulip mania for a second, because I'm always referring to it, and I don't think a lot of people really understand how that came about. What got you so fascinated with the tulip mania bubble? I want to relate that to some of the bubbles we've seen more recently."

Burton: "The tulip bulb was really the classic investment bubble, and 'classic' both because of how high tulip bulb prices went, but how ridiculous it seems in retrospect that people started speculating on tulip bulbs, and that a single tulip bulb could cost as much as a nobleman's castle. And so, since avoiding bubbles—avoiding getting swept up in some mania—is so important for investors, I thought it was useful to recount that classic mania."

"Tulips originally came from the Middle East; they were introduced into Holland. People loved tulips, and they started a speculation that made a single tulip bulb double, and then double again, and then double again, with one tulip bulb eventually selling for about the equivalent of what a nobleman's castle would sell for. And then, of course, what happens with all bubbles is eventually some people say, "Hey, wait a minute, why should we pay that much for a single tulip bulb?" And all of a sudden, the bubble deflates, crashes—and in Holland, tulip bulbs would then be lying on the ground essentially worthless."

Caleb: "You do such a great job in the book, at talking about how to control our behaviors. I'm going to list some of the tips you mentioned there—ignoring your friends—especially those that are trying to coerce you into buying something, avoiding over-trading, selling your losers—not your winners, avoiding hot IPOs, avoiding hot tips and people out of breath. I love that section of the book, where you're talking about that breathless salesman, or the breathless broker that wants to get you in on something. How important is it to be able to control our behavior? It's such a simple thing to say, but such a hard thing to do as investors."

Burton: "The two things that are so important to control are, one: avoiding getting swept up in the bubbles, and two: how difficult it is to be a disciplined saver. You know, one of the things that I show in the book—and there's a wonderful chart, or rather, a table, that shows starting from the time that index funds became available, that if you just had a person who had the discipline to save something like $20 a week, and invest it in an index fund, that over a 40-plus-year period—that with just those kinds of modest savings, you could actually have $1.5 million today."

"But the discipline to say, "I'm going to save regularly, I'm going to pay myself first out of my salary. Even if I'm living paycheck to paycheck, I'm going to take a few dollars out and put it aside, and I'm going to invest no matter how pessimistic everybody is about the future. I'm going to just keep that up as a regular, regular thing."

Caleb: "I love some of the other concepts you get into, including our concepts and our notions around risk. And the way you describe it in the book is, "What's your sleeping point?" Talk to us about your sleeping point, and how that's so important to know, and be comfortable with, as an investor."

Burton: "The line comes from a famous remark of J.P. Morgan, where a friend of his was saying, "I'm just so worried about my investments. I can't sleep." And J.P. Morgan said, "Well, sell down to the sleeping point." If you're that kind of person, just make sure that your portfolio is balanced with a lot of relatively safe investments, including even Treasury Bills."

"If someone has that kind of temperament today, I would say, "Look, you can buy a two-year Treasury security that yields almost 5%." I think common stocks are going to do better over the long run, but you ought to have enough of your portfolio in that kind of investment, so that you don't have to worry if the part of your investment that's in common stocks is, in fact, very volatile."

Caleb: "How about the efficient market hypothesis—popularized, of course, over the last few decades, but something you write about a lot. Again, we've had a lot of dislocation of markets, and some of that is because of, you know, a lot of new investors rushing into the market over the past couple of years, certainly in lockdown. But do you still believe in that? Is that still a tenant out there that investors should pay attention to?"

Burton: "Yeah, I still believe in it, and believe in it just as strongly as ever. What the efficient market hypothesis means, simply, is that information gets recorded into prices quickly. So that, if a drug company has just found a new cure for cancer, and that should double the price of the company's stock, the price will react today—it won't react slowly over time. And I do believe that that does still happen."

"Now, a lot of people say that the problem with the efficient market hypothesis is that it means that prices are always right. And that's not right—prices are not always right—prices are always wrong. Some people may think that the new cancer drug will triple the price of the stock. Some other people will think it will only increase the price of the stock by 50%. So the market won't get it exactly right. But nobody knows for sure whether the price is too high or too low."

"And so, what the efficient market theory says is that market prices may not be right. In fact, they're probably always wrong, but nobody knows for sure whether they're too high or too low, and in fact, the market does a reasonably efficient job of getting it right—so efficiently that to try to bake your own bets, and picking a portfolio that you think is going to do better than the market portfolio, just doesn't work."

"One of the things that I've been able to do in the 50 years since the Random Walk book was first published is to look at the results. And the results are that year after year, two-thirds of active portfolio managers—the professionals—are beaten by a simple index fund, and the one third who win in one year aren't the same as those who win in the next year, so that when you compound this over ten or 15 or 20 years, you find that 90% of active funds underperform a simple low-cost index fund."

Caleb: "Let's talk a little bit about what you've been doing with Wealthfront. Wealthfront again, very popular digital investing and personal finance platform—one we review and rate pretty highly here at Investopedia. What's your relationship with Wealthfront, and why Wealthfront?

Burton: "I signed up with Wealthfront because it was doing precisely the kind of thing that I've always recommended in the book, in that what it does, is it puts together a portfolio of very simple index funds—a total stock market fund, a total international fund, an emerging market fund, a bond fund. It actually puts together portfolios of low-cost index funds, which is exactly what I think people should do."

"But it does something else, that I think is actually very important, and that is, it does something called tax-loss harvesting. Now in the investment world, outperformance is generally called 'alpha'. To the extent that you make 1% more than the market—that's what investment professionals call gaining an alpha. Now, I'm skeptical that people gain alphas, as I've suggested to you. There are few people who've done it in the long run. But by-and-large, it doesn't happen. But the surest way to get an alpha is through tax loss harvesting."

Caleb: "Let's get into a lightning round here. I hate to make you do short answers, because you have so many great things to say, but we're going to try to do 10 seconds on each response here, because I'm just so curious on your reaction. So let's get started. Are you ready?"

Burton: "Ready!"

Caleb: "I'll say a name or a word, and you give me your word association with it. Let's begin with Warren Buffett."

Burton: "Great long-run investor and believer in index funds."

Caleb: "Elon Musk."

Burton: "Clearly a genius from forming Tesla, but may maybe like a lot of geniuses, a bit crazy."

Caleb: "Jeff Bezos."

Burton: "Again, a genius in forming Amazon, and a great help to America's consumers."

Caleb: "Jack Bogle."

Burton: "Probably the investor who's done more for the small investor than any other person in the world."

Caleb: "ESG."

Burton: "I'm skeptical, because I am not sure that really one is conforming to the ESG ideal, and I worry that people will get neither good returns nor moral investments."

Caleb: "Cryptocurrency."

Burton: "I am a skeptic. A complete skeptic. We will have cryptocurrencies in the future, but governments will be the ones who initiate them."

Caleb: "Wall Street Bets—the Reddit forum."

Burton: "Again, basically a gambling casino."

Caleb: "You've written one of the great books on investing, but what is your favorite book on investing that's not yours?"

Burton: "I would say that Jack Bogle's classic book on mutual funds would be one of them. Another one would be Charlie Ellis's book, Winning the Loser's Game. Again, both of them quite consistent with the ideas that I put in Random Walk."

Caleb: "Yeah, timeless, just like your book as well. All right, what are your predictions for 2023? Doesn't have to be market-related, but if it's investor-centric, even better. But what do you think is out there, that either isn't getting enough attention or maybe is, but is actually a bigger deal than people might think?"

Burton: "What I am more worried about than other investors, and it's both for 2023, 2024, and 2025, is I am afraid that the inflation that we have is going to be far more persistent than a lot of people think. And I think it for two reasons. I am worried because of the demography. We have an aging population and a population that's not growing, and the labor force is not growing. So I think the labor shortages that we have now are not going to end very easily. And we, as a country, seem to have an animus against immigration, which would be one way we solve the problem, because the emerging parts of the world are growing and are young. So I worry about the inflationary pressures from not enough labor."

"I'm also worried about the inflationary pressures that will come from our feeling of hate towards globalization. Globalization has been a great force to bring prices down, and we seem to be retreating from globalization. We seem to be retreating from wanting to trade with China and other emerging nations. And I do worry that the situation is likely to be very, very difficult for 2023 and beyond."

"Now, having said that, I want to go in with the advice, but you should still stay the course, because what if we have a decade of stagflation? Now, I'm not suggesting it's going to be that bad, but it could be. What happened during our last decade of stagflation—the 1970s? Should you have stopped investing then? Despite the fact that the Standard and Poor's index, at the end of the decade of the 70s, was the same as it was at the beginning, and that we had very low growth, and that we had high inflation, the answer is no."

"The reason is that if you engaged in regular dollar-cost averaging, you made 6.5% per year on each dollar invested, even in that terrible decade. And so, even if the worst happens, the worst being that we're going to have some stagflationary tendencies in 2023 and beyond—still stay the course, still invest—equities are the best long-run inflation hedge that we know of. And yep, things could be very tough next year and beyond, but stay the course."

Caleb: "Great advice, as usual, and you're dropping so many great gems—and dollar cost averaging, of course—one of the secret ingredients to building wealth, along with compounding, that makes investing in stocks and in index investing so powerful. All right—let's go out on this. You know we're a site famous for our investing and finance terms. You've dropped so many gems on us today, but I'm wondering, do you have a favorite investing term that just speaks to your soul?"

Burton: "Well, really, a couple of them. Index funds—I can't stress enough echoing Jack Bogle, because it was his expression, "stay the course." Keep the discipline of regular investing and be modest—don't think that you're smarter than the market. The market's not always right, but it's very, very hard to beat. Bow to the wisdom of the market."

Caleb: "So good, so valuable. Professor Burton Malkiel, the author of A Random Walk Down Wall Street: The Best Investment Guide Money Can Buy. You're also the Chemical Bank Chairman's Professor of Economics, Emeritus, and the Senior Economist at Princeton University and the Chief Investment Officer for Wealthfront. But more importantly, and most importantly for us, you are one of investors' best friends. It is a delight to have met you, and thank you so much for coming on the Investopedia Express. We are honored."

Burton: "Thank you very much for the wonderful questions."

Our Top 10 Terms of 2022

It's terminology time. Time for us to get smart with the investing term we need to know, this week. And this week, we're not going to give you just one term. We're going to give you 10—the Investopedia Top 10 search terms for the year 2022.

Number one: 'poison pill', and we can thank Elon Musk for 2022's top term of the year. 'Poison pill' is a colloquial term for a defense strategy used by the directors of a public company to prevent activist investors, competitors, or other would-be acquirers from taking control of a company by buying up large amounts of its stock. On April 14, 2022, Elon Musk made an unsolicited offer to purchase Twitter at $54.20 per share. Twitter's board initially responded with a poison pill strategy to resist a hostile takeover. Ultimately, the board relented, and Musk captured the blue bird.

Number two: 'recession'. This word has been on everyone's lips in 2022 because of that sticky high inflation and rising interest rates, which are usually a recipe for a recession. A recession is defined as a significant, widespread, and prolonged downturn in economic activity. Given current economic forecasts, expect this term to remain popular next year.

Number three: 'hostile takeover'. This is another term that popped up thanks to Elon Musk and Twitter. Musk's unsolicited bid to buy Twitter on April 14th was considered a hostile takeover, which refers to the acquisition of one company by another company, against the wishes of the former.

Number four: 'bear market'. Even though 2022 was the Year of the Tiger, Bear stole the show this year.

Number five: 'cold storage'. Cold storage and cold wallets became very popular this year, as cryptocurrency investors reacted to news of record-breaking digital asset hacks online. Cold wallets are digital wallets not connected to the Internet, and therefore less vulnerable to the hacks and downfalls of online systems.

Number six: 'federal funds rate'. The term 'federal funds rate' refers to the target interest rate set by the Federal Open Market Committee (FOMC), and it's the rate at which commercial banks borrow and lend their excess reserves to each other overnight.

Number seven: 'capitulation.' Think of capitulation as throwing in the towel. Capitulation in investing describes when a significant number of investors succumb to fear, and sell over a short period of time, causing the price of a security or market to drop sharply amid high trading volume. While the S&P 500 fell as much as 25% from its highs this year at its low point, most investors never really capitulated as they did in past bear markets, given the reports from several online brokers.

Number eight: 'gilts'. Government bonds in the U.K., India, and several other Commonwealth countries are known as gilts, which are the equivalent of U.S. Treasury securities in their respective countries. On Sept. 22, British government bond prices, or gilts, had their largest drop since the start of the COVID-19 crisis in March of 2020, as then-Prime Minister Liz Truss attempted to push forward an economic agenda of tax breaks, amid rampant inflation. She was forced to pull back her plan, and fire her finance minister, and the blunder eventually cost her her job.

Number nine: 'petrodollars'. Petrodollars are crude oil export revenues denominated in U.S. dollars. On Feb. 24, Russia invaded Ukraine, which contributed to pushing crude oil prices higher than $125 per barrel last spring.

And number ten: 'core inflation'. Inflation was top-of-mind and one of our most popular terms all year, especially as the annual rate of inflation hit a 40-year high. Core inflation is the change in the cost of goods and services, excluding food and energy prices. Food and energy prices are exempt from this calculation, because their prices can be too volatile or fluctuate wildly, as we saw all year long, and that's why core inflation was so popular.

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