Handbook of Finance: Investment Management and Financial Management

Chapter 38. Are Stock Prices Predictable?

PETER L. BERNSTEIN

President, Peter L. Bernstein Inc.

Abstract: "Can stock market forecasters forecast?" asked Alfred Cowles in 1933. He concluded, "It is doubtful." Cowles was by no means the first to suggest the impossibility of systematically and consistently correct market forecasts, nor was he even close to the last. Yet the attempt to forecast stock prices has only gained momentum over the years, and today keeps an entire industry of security analysts, portfolio managers, television pundits, software peddlers, and newspapers humming. Even so, even the smart do not necessarily become billionaires. Today's answer to this puzzle is the efficient market hypothesis developed in the 1960s, but as long ago as 1900, the obscure French mathematician Louis Bachelier, concluded after a long study of the matter, "[Fluctuations depend] on an infinite number of factors [so that it is] impossible to aspire to mathematical predictions." How can we ever know where the market is going when, for any quoted price, there are as many shares bought as shares sold? How can we predict a number that is already a prediction of a number?

Keywords: Dow Theory, Cowles Commission, Econometrica, Louis Bachelier, Charles Dow, Alfred Cowles III, mathematical expectation

Paul Samuelson, economist and Nobel laureate, once remarked that it is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office. All investors, professionals as well as ...