"Don't look for the needle in the haystack. Just buy the haystack!" – John Bogle
Early in 2022, we did an installment of this column called When Volatility Smiles At You, Smile Back in which we discussed the risk revolution ushered in by the insights of Fisher Black, Myron Scholes and Robert Merton. Disruption isn’t always achieved by shiny things; sometimes simple algebra will do. The Black-Scholes model revolutionized investing and made it so “one bad season doesn’t have to ruin the farm.” The risk management revolution Black, Scholes and Merton unleashed was one of the most profound in the history of Wall Street. The only intellectual revolution on Wall Street in the last decades that’s been of equal or greater significance was the move toward passive vehicles that allow investors to insulate themselves from the idiosyncratic risk of single stocks -- exchange traded funds (ETFs).
Stock picking is incredibly challenging and highly time intensive. You might pick a great company, and they might even beat earnings estimates just like you thought they would. Still, if this occurs at the wrong time alongside tepid guidance, the company's stock might plunge in price regardless of the excellent research you did to identify the company's prospects. Your stock pick might be good, on the other hand, if idiosyncratic factors are responsible for most of the price movement. However, during anomalously high market stress, correlations between stocks can move toward one. In market conditions where macro factors drive price action, how well your company is performing or being managed may have minimal bearing on its price action.
Ok, so everyone knows stock-picking is hard, and if you think it isn't, you're probably about to find out that you're wrong. Many argue that stock-picking is a fool's errand and that any success, or the illusion thereof, will be fleeting and will normalize over time. Burton Malkiel most famously advanced this concept in his must-read 1973 book, A Random Walk Down Wall Street, that stock prices operate on a random walk - that is, behave randomly.
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