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Jeff Schweitzer Headshot

In God We...Invest

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Our financial institutions do not need to be regulated, they need to be prosecuted. No matter how effectively pending legislation in the end reigns in market excess, the new law can be nothing but a fig leaf barely covering the nether regions of a the hoax we call Wall Street.

For two decades I have pondered how the institutionalized fraud of Wall Street could survive even the most cursory investor scrutiny. Our financial sector is built on a bed of demonstrably false assumptions that we collectively pretend to believe; market analysis is the con art of reading tea leaves sold as hard science; our investment advisors make bogus projections to generate trading fees. Our government creates a body of law that confers legitimacy on the massive fraud. So like sheep being led to slaughter, we dumbly enter this funhouse of mirrors with a blissful hope unique to the ignorant. Wall Street is nothing but a government-sanctioned swindle, and you are the mark.

I finally understand how deception on such a massive scale can be perpetuated. The same disease of a hypertrophied central nervous system that allows us to believe in talking snakes, rebirth of the dead and an invisible man in the sky with magical powers also compels us to buy the fantasy sold to us by the charlatans of Wall Street. The entrenched ubiquity of religion in our species proves we that we easily accept the fantastic, with no need for evidence, proof, or rational thought of any kind to justify the belief, no matter how absurd. We believe because we have faith, and faith requires no proof. We believe because we want to. And that is precisely why we can be so easily conned by the gurus of the financial sector. We want to believe that we can all become rich without work and with no risk, that our money is in good hands, that we invest on a level field with everybody playing fair and by the rules, and that with enough sophisticated analysis people smarter than us can actually predict the future for us so we know where to drop our money. Brokers, bankers, traders, analysts and their army of shills gain our confidence with slick prospectuses, unique "tips" available only to special customers, and knowing winks hinting at huge returns, all to defraud us of our hard-earned money. This scheme central the functioning of Wall Street is the definition of the traditional "confidence trick" also known as a bunko, hustle, scam or swindle.

Wall Street is our secular religion. As with more traditional beliefs, faith trumps reason. That explains our willful blindness to the obvious scam, the fantastic story told to us by billionaire bankers. Wall Street in fact has all the trappings of a traditional religion. Of course any religion must have an object of worship, and Wall Street is no different. All pray to the ideal of an unregulated market, a deity that provides for limitless wealth gained, if necessary, at the expense of others through deceit and fraud. We even have our own cathedral, the New York Stock Exchange, looking every bit like a classic Greek Temple. The Federal Reserve Chairman serves as pope, an aloof figure uttering obscure proclamations that minions parse for deep meaning. The high priests or cardinals are the CEOs of Goldman Sachs and JP Morgan Chase, spending lavishly other people's money to perpetuate the illusion of power. Serving as archbishops are the leaders at Citigroup and Bank of America, who cover up misdeeds of greed and excess at home and in the system at large to protect the institution from external scrutiny. Bishops are the titans of our biggest industries, who rely on the fraud perpetrated by Wall Street to sell shares in a market rigged with insider trading and corruption. Brokers act as our local parish priests and ministers, to whom we confess our greatest hopes and deepest concerns. Feeding the hierarchical chain are, finally, the deacons, Ivy League business school students waiting for ordination. Like their Catholic counterparts, these secular religious leaders are enmeshed in scandal; and many abuse our children -- stealing their future by bilking unsuspecting parents, who simply cannot believe their trusted broker would do such a thing.

As is traditional religion, Wall Street is founded on myth, free from the constraints of any objective truth. Our financial system relies on our belief in the fundamentally flawed idea that the future is predictable. Elaborate stories are told to support the myth. We all walk around with the idea that the past is prelude, that a trend behind will continue ahead, and that what once was always will be.

Until it is not. The future is not predictable. That fact is why Wall Street is a fraud because the entire enterprise is based solely on the alluring myth of predictability. We want to believe we can know the future, and we have faith we can if we can just gather enough information, do enough research. But we cannot. Airline executives thought their business models could project earnings to the next quarter, until a volcano erupting in Iceland proved every assumption wrong. We witness here the Black Swan so eloquently explained by Nassim Nicholas Taleb in his book of that title. We might believe that every swan is white because all we've seen to date has validated that assumption. We have observed millions of swans over decades, and every single one has met our expectations. Therefore, we have complete confidence in our conclusion that all swans are white. Until we see one black swan. All it takes to destroy our basic assumptions is one bird. Or one volcano. Or one bankruptcy.

People make the mistake of dismissing these highly improbable events as outliers, something to ignore as an anomaly in creating models to predict future behavior. That is a fatal error, because these improbable events are embedded in the fabric of the future, and by definition are not predictable. Yet when these inherently unpredictable events occur, they alter completely the course of our future in ways we can never anticipate.

The future is deterministic, but unpredictable, just like any chaotic system. We will simply never know enough about all variables to make truly useful predictions that will stand the test of time. What passes now for strategy, research, investment systems and wealth-building methods are nothing better than reading the pattern of scattered bones. This fundamental truth has long been understood on Wall Street, but willfully ignored. Testifying before the Senate in 1967, Nobel Prize-winning economist Paul Samuelson declared: "A typical mutual fund is providing nothing for the mutual fund owner that they could not get by throwing a dart at a dartboard." He was rekindling an idea initiated 40 years earlier by Edgar Lawrence Smith, who presented in 1926 the first credible attempt to estimate the long-term return on stocks through empirical analysis. In his book Common Stocks as Long Term Investments, Smith looked at stock investments assuming no market timing or stock selection ability whatsoever; instead he used a hypothetical investor who simply held onto stocks, and found that such an investor outperformed professional bond investors.

Burton Malkiel published in 1973 his now-famous attack on the financial establishment in a book entitled, A Random Walk Down Wall Street. With this book, Malkiel launched a direct and aggressive challenge to the authority of Wall Street, and his work was and is still today reviled by brokers and others with a vested interest in the status quo. In his publication, Malkiel postulated that a blindfolded monkey throwing darts at a newspaper's stock tables could outperform any stock picker over time.

These authors knew that once you enter the market, at that precise moment you have exactly a 50.00000% chance that the stock will move up or down in price. Nothing you do beforehand, no amount of research, no amount of technical or fundamental analysis, no amount of wishing upon a star will change that simple fact. But there remains one more important element: when you exit the stock market, you have exactly and precisely a 50.00000% chance that the market will move up or down from that moment forward. Any effort to change that rule of nature, to nudge that 50% mark off center, is completely and hopelessly futile. Try and you will fail. Once you enter the market, you can only know one thing: with time the market will go up or go down. Any statement or claim beyond that is witchcraft, and you can never predict which of the two will prevail for any one stock.

But because Wall Street is a religion, these inconvenient facts of nature are abandoned for faith in predictability, no matter how ridiculous that may be. And as with religion, story upon story is told to bolster the myth. This is seen clearly in the laughable analyses published daily in major newspapers, which proudly feature "experts" who explain ex post facto why the market moved in a particular direction. Let's say new unemployment figures are to come out, and are widely expected to push the market down. But instead the market reacts by going up. The self-proclaimed "analysts" will say, with no hint of irony or embarrassment, "The market had already anticipated the bad news." But if in fact the market had gone down, those same experts would claim brilliant predictive powers, and conclude that bad employment news "caused" the market loss. No matter what happens, these charlatans can create any explanation they want to fit the know facts, after the fact. The analysis is truly useless, and if not embedded in the traditions of a secular religion, would be seen by all as embarrassingly ridiculous.

The future's inherent unpredictability is a fact of nature, an immutable reality that cannot be altered, anymore than we can turn off Iceland's volcanic eruption. Wall Street fraudulently says that we can ignore the volcano and continue pretending the future is ours to see. They are deeply, purely, absolutely wrong. But faith trumps reason. Because of that we are living a lie while collectively pretending otherwise. Myth and false assumption are no foundation for a prosperous future.

Reason offers better hope. Our futures would be better secured if we shed the misguided comfort of secular religion to create a truly transparent market, highly regulated to minimize the impact of corruption, greed and fraud, and free of the false assumption of predictability. This is not impossible. Organizing the market around the principles of Random Walk is a possibility, but a bit impractical. The point here is that to shift toward a market based on truth rather than myth we first must stop lying to ourselves. We must embrace the cold reality of outliers and the Black Swan. We as investors must take point in this march to reality. If we stop believing the lies then the deceit no longer matters. Next time your broker calls with a stock tip, tell him to take a hike. We can throw darts as well as he can.