The Folly of Stock Picking and How to Handily Beat the Stock Pickers

June 13, 2023

By Cindy Spitzer

This year marks a half century since the bestselling book, A Random Walk Down Wall Street, by economist Burton Malkiel, first warned investors in 1973 that the stock market is, by nature, unpredictable and that trying to beat the market with “smart” stock picks is futile. In fact, compared to simply investing in a variety of randomly chosen stocks, most highly analyzed portfolios of carefully chosen stocks, on average, fail to match the growth of the overall market over time.

In other words, almost every amateur and professional investor would be better off just buying a low-cost S&P 500 index fund than trying to pick winners.

Yet the vast majority of investors, analysts, brokers, advisors, and money managers of every description, from Main Street to Wall Street, remain doggedly committed to stock picking.

Here’s why Bull Bear Investment Management doesn’t pick individual stocks – and why most people still do.

Stock Picking Doesn’t Work

Stock pricing has long been difficult as “A Random Walk Down Wall Street” points. But more recently, even the best investors in the world – people like Warren Buffett and Ray Dalio – have repeatedly failed to outperform the overall stock market. In fact, most highly respected stock-pickers (including Mr. Dalio and Mr. Buffett) have been unable to even match, no less beat, the market since the 2008 Financial Crisis.

The problem is not that smart stock-pickers have lost their mojo; the problem is the market itself. Decades ago, we had a stock market primarily driven by fundamentals. Even back then, researching and picking good stocks was never easy, but with exceptionally smart analysis, the best investors became quite good at it. Thoughtfully picking good “value” stocks, for example, helped Buffett build an empire.

But those days are long gone. Since the 2008 Financial Crisis – and especially since the 2020 Covid Crisis – truly enormous government stimulus (in the form of massive money printing and borrowing) has driven the stock market higher and higher. Even with last year’s downturn, the market is still on an overall upward climb due to many years of massive government support.

Not only is beating the overall market unlikely, even matching the market can be difficult. That’s because in this post-Financial Crisis market, individual company stocks, even when properly analyzed, can perform very differently from what a good analysis would predict.

Unless you get lucky, stock picking generally doesn’t work in the current environment, even for the best stock picking investors in the business.

If It Doesn’t Work, Why Do Most Investors Still Love Stock Picking?

I think the answer comes in three layers. The first reason is pretty straight forward: we like gambling. The second reason is a bit more subtle: we like the bubble and want to keep it going. The third reason, however, is even deeper and more powerful.

Reason #1: Like a Bunch of Lab Rats, We Like Gambling

Decades ago, scientists discovered that if they gave lab rats a tasty treat every time they pushed a pellet-dispensing bar, the rats would eventually lose interest. But when the treats only showed up occasionally and randomly, suddenly the rats started pounding their potential treat bars, over and over, all day long.

The technical term for this is “intermittent reinforcement.” It means that getting a payoff randomly, with no predictable pattern, tends to motivate many animals, including humans, to keep trying to get it again and again.

Intermittent reinforcement is why many people find casino slot machines so enticing. You know a big jackpot win has happened before and you know it will eventually happen again – you just don’t know when it will happen again, so you keep trying.

It’s not all that different with stock picking. No one knows the future, but the fact that stock picking does work some of the time is reinforcement enough to make many investors want to keep trying, again and again. And unlike lab rats and slot machine gamblers, many of us believe if we are smart enough and if we do enough due diligence and research, we can greatly up our odds of picking a winner.

Sometimes we do win! But more often, we don’t.

Reason #2: Everyone Loves the Bubble

The second reason most investors like stock picking is because, consciously or not, just about all of us have a stake in keeping the big, artificially stimulated stock market bubble going. No one wants to see their assets lose significant value, even if they suspect (and most people don’t suspect) that today’s stock values are largely due to years of massive government stimulus.

To protect the bubble, investors need to act as if all is well and there is no bubble. Stock-picking worked just fine before the bubble, and it also works just fine now – because, you see, there is no stock market bubble.

Up is good and down is bad. If we want the stock market to go up (and the bubble to stay up), we need to buy stocks!

So, along with intermittent reinforcement, I think our shared desire to keep the bubble going plays a role in wanting to keep stock picking going.

But I also think that, beyond all this, there is a deeper reason for our shared cultural devotion to stock-picking – a reason most of us would rather not think about.

Reason #3: Facing the Folly of Stock Picking is Scary

We all want the comfort of believing that the financial world makes sense, that the stock market makes sense and that if you are smart enough and try hard enough you can make enough good stock choices to beat the market.

It is terribly threatening to our sense of financial security to think that economic and financial conditions have changed, due to massive government intervention, and now stock picking doesn’t actually work.

If we face the fact that stock picking in today's screwed up stock market doesn't actually work so well anymore, then we would have to face the fact that our economy and financial markets are now being driven by government stimulus and not fundamentals. And, most people recognize, that a government stimulus driven economy is not sustainable long term and will eventually blow up.

That’s a very uncomfortable thought.

Today’s Stock Market is Screwed Up Because It is No Longer Driven by Fundamentals

Based on extensive analysis described in our books (click here), we believe that eventually most investors are going to suffer significant losses when all this massive stimulus eventually causes massive negative consequences. And the economic and financial damage done by this stimulus will take decades to overcome. It won’t be another quick dip followed by a stock buying opportunity.

But even if that never occurs, today’s stock market is no longer running on fundamental drivers of growth. Instead, it’s running primarily on massive government stimulus (past and future massive money printing and borrowing).

A stock market driven primarily by massive government stimulus rather than economic fundamentals is an abnormal market. In an abnormal market, the only way to beat the market with a rare winning stock pick is to get lucky. And if you do happen to get lucky, what are your odds of getting lucky again?

If picking a winning stock is both rare and unpredictable, then no matter how smart you are or how hard you work at it, you really cannot consistently "win" in the old way of winning, because the old way of winning is no longer available. The old strategies are no good because the system itself is now no good.

Few people have the appetite for facing that. Far better to just keep trying to pick winning stocks, even if it rarely works.

Besides, what else can we do?

Winning Without Stock-Picking

The best way to give up something that doesn’t work is to replace it with something that does work. However, in this case, doing so requires some independent (and perhaps uncomfortable) thinking. Are you ready to consider something radically different that actually works?

Instead of picking individual company stocks, Bull Bear Investment Management invests in ETFs (exchange traded funds) that represent the S&P 500 index – a highly diverse group of 500 well-established companies across a broad spectrum of industries. That means when the S&P rises, our investments rise as well. And for those who want to outperform the market, we add partial allocations of leveraged ETFs that rise faster than the S&P.

Unless you think the S&P will never rise again, this is one of the best ways to keep up with, and if you wish, beat the stock market. (By the way, anyone who thinks the S&P will not generally rise in the future should not be in the stock market at all.)

The beauty of this strategy is two-fold.

First, the S&P 500 is a rock-solid group of 500 blue chip stocks, widely diversified, and about as good a stock investment as you can get. By buying the S&P index, the ability to keep up with (and potentially outperform) the S&P is baked into our investment strategy. No luck required.

Secondly, this approach is historically supported and effectively backstopped by the tremendous market-boosting power of the US Federal Reserve (with massive money printing) and the US Congress (with massive money borrowing), both of which support the stock market.

Yes, the S&P sometimes goes down, sometimes quite significantly. But the Fed has demonstrated again and again that it is not going to allow the S&P to fail. Can you name even one individual company stock that can make such a stunning claim? Congress and the Fed have little interest in supporting any individual stock, but they have an enormous interest in supporting the overall stock market, which is essentially the S&P 500.

The combination of no luck required and the Fed’s massive printing press for support if the going gets rough makes buying an ETF that tracks the S&P 500 index the smartest and easiest way to match the generally rising stock market.

It’s certainly much better than trying to pick stocks, as proven for many years.

And for those who want to beat the S&P, a partial allocation to a leveraged S&P index ETF makes that possible without the usual risks of buying on margin.

By How Much Would You Like to Beat the S&P?

Without promising a particular return, our trading strategy lets you pick your performance level relative to the S&P. That means, depending on your investment goals and volatility tolerance, you can choose to match, out-perform, or under-perform the market.

For example, you can choose to roughly match the S&P 500, or you can select a portfolio model that tracks at about 1.5 times the S&P, or you can choose to somewhat under-perform the S&P, depending on your comfort level (click here for details).

Most Importantly, We Aim to Exit the Market Before the Bubble Pops

Massive money printing (almost $8 trillion since 20008) and massive money borrowing (now more than $31 trillion total federal debt and rising) is not infinitely sustainable and will eventually cause significant negative consequences.

That is not occurring now, but if and when it happens, it will be devastating for stocks, bonds, and real estate. If so, we won’t have to “time the market” perfectly as long as we pay close attention to the growing rapids before the waterfall and exit the stock market entirely before the bubble pops.

Key indicators, such as rising double-digit inflation and rising interest rates that the Fed cannot control, will signal us to move from interest-rate-sensitive assets (stocks and bonds) to non-interest-rate-sensitive assets, such as gold, gold mining stocks, and other investment opportunities (click here for details).

In the Meantime, Let’s Take Advantage of this Massively Supported Stock Market

Despite last year’s market downturn, massive government stimulus (past and future) is still driving the stock market on its overall upward climb. It makes no sense to pursue stock picking when you can easily seek to match, or even beat the market, without having to roll the dice on individual stocks.

Giving up stock picking can feel uncomfortable. However, knowing ahead of time what percent of the S&P performance you are intending to achieve may leave you feeling oddly relaxed.

As A Random Walk Down Wall Street warned 50 years ago, trying to pick winning stocks is – over time -- futile. It’s far better to simply get in the overall stock market and ride it up.

We agree completely, with one caveat: It is also far better to get OUT of the market entirely later, before it crashes over the Financial Cliff.

Luckily, it is very possible to do both: ride the Bull now as the market rises and dodge the Bear later, if and when the bubble pops.

In fact, at this point, I think it is the only investment strategy that makes any sense.

Click here to schedule a no-cost consulting call with Cindy Spitzer, senior investment advisor, Bull Bear Investment Management.