If you read yesterday’s long column, it may well have left you with this question: Well, what if everybody threw up his hands and decided he couldn’t beat the market and so stopped trying?

The short answer is: it won’t happen, so forget about it. The only slightly longer answer is: well, if that happened, then you could beat the market. In markets that are not efficient — where people are not trying hard to evaluate products and prospects and managements and competitors and regulatory climate and everything else — some companies will be foolishly overvalued and others, foolishly undervalued. (And with hindsight, it will always be clear which group was which.)

I doubt this will ever happen with shares of, say, IBM or Intel — not to say that the crowd of money managers can’t get unreasoningly carried away with even these big stocks in a mass euphoria or panic. But market inefficiencies are more likely to occur in the backwaters, and perhaps in those parts of the market dominated less by sharp-pencil MBAs with their spreadsheets and discounted-cash-flow models than by guys (why is it almost entirely guys? And did you know guys have been documented to do worse at investing than gals, basically because they have more confidence in their ability and thus trade more, racking up more transaction costs?) looking for the next hot one on Internet chat boards.

So, yes, if the entire world simply bought index funds, then you could easily beat the market by investing only in the undervalued stocks and eventually getting rich off their increasing profits and dividends, bought for a song. Better still, perhaps, by shorting the ones you could see were headed for bankruptcy. (Presumably, in bankruptcy, or surely in complete liquidation, the stocks would be eliminated from the index and thus decline in price, suddenly, to zero.) But even when there’s little real chance of beating the market consistently, most investors try (either themselves, or through actively managed mutual funds). So imagine how much harder and eagerly they’d try if a normal bright guy with two hours a day to spare really could expect meaningfully to beat the market! And there you’d be again: millions of people making their best judgments trying to predict the future prospects of companies and earnings and stock prices, and a more or less efficient market that “knows” everything there is to know and that is, thus, hard to beat.

 

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