Is the Market Stacked Against You?

Are the markets rigged?

Yahoo!'s Daily Ticker discussed that last week with blogger and commentator Barry Ritholtz. If you read the article that accompanied the video, the conclusion seems to be a pretty clear "yes." They write:

Meanwhile, more evidence the stock market is not a level playing field: 47% of respondents in a survey of 400 investors from across the world found one-on-one meetings with companies regularly lead to price sensitive information being divulged, according to the Rotterdam School of Management.

Surveys like this, along with the Rajaratnam trial, the saga over David Sokol's Lubrizoil trades and a overwhelming sense the market is stacked against them helps explain why mom & pop haven't piled back into stocks even after a more-than 2-year bull market.

The article concludes by noting that though Ritholtz said that insider information isn't always a slam dunk, "Either way, it's not the way you want the markets to function."

That's strange...
Normally I don't watch videos like this. I'm a relatively fast reader, and so I'd rather fly through the text than meander along at the pace of the video. But this time I'm very glad I took the time to watch.

Perhaps is my own perspective (and bias) at work, but listening to Ritholtz talk, it sounded an awful lot like he was making a case for markets not being rigged -- at least in any sort of underhanded or illegal way. To be sure, he seems to think that the odds are heavily stacked against Joe and Jane Average. Given the time, resources, and experience that hedge fund and other institutional investors have, that's probably not much of a stretch.

However, Ritholtz seemed to be explaining that most of the edge comes from these investors' ability to take information that everyone else has access to and come to a different conclusion. He called out well-known short-seller David Einhorn here and the fact that he took a long stake in Yahoo! after apparently seeing something in the balance sheet that he believes other investors have overlooked.

He also talked about how some professional investors stack the odds in their favor by sticking to a certain philosophy that's been proven out over time. Here, he highlighted Whitney Tilson and Warren Buffett as value investors -- a style of investing that has been shown again and again to outperform over time yet elicits snores from the go-go investing crowd.

In short, though, it seemed to me that Ritholtz's case was that individual investors are stacked against highly skilled competition but not a bunch of crooks with illegal information.

Philosophy, you say?
But it was Ritholtz's mention of philosophy that stood out in particular for me. I am fully in agreement that individual investors face a tough head-to-head matchup with institutional investors on many levels. However, I think that one place where we can actually gain an advantage is in the philosophy department. Or rather, I probably should say execution of philosophy.

While many institutional investors profess to be long-term oriented, it's incredibly difficult for them to truly take a long view in their investments. For one thing, performance -- and therefore fees, comparisons to other funds, and investors' view of their stewardship -- tend to take place on a one-year basis. So it can be tough for them to look five years out when they know that their paycheck and ability to keep investors from pulling out will happen on the basis of this year's performance.

For individuals, though, there are no potentially angry investors to deal with -- just our own bias-laden minds. Assuming we can master our own urges to be our own worst enemy when it comes to our investments, we stand a much better chance of actually being able to invest for the long term.

Beat the fix
If you really are concerned about the markets being rigged, taking a longer-term view of your investments may help you sleep better. Consider some of the trades that Raj Rajaratnam allegedly made with insider information.

According to the SEC, on June 11, 2008, Rajaratnam bought a boatload of Goldman Sachs (NYSE: GS  ) stock and options after receiving a tip that the company was going to report strong earnings. On June 17, the company came through and did post a better-than-expected quarter, and Rajaratnam sold his Goldman shares after reaping a quick gain.

In January 2009, Rajaratnam supposedly shorted a bunch of Procter & Gamble (NYSE: PG  ) stock on a tip that the company would announce a lower projected growth range. He allegedly pocketed $570,000 a day later when he covered the short.

Now don't get me wrong -- there's nothing right or just about insider trading. However, how do trades like these hurt you as a long-term investor? Rajaratnam may have had a timing edge in getting the information above, but it actually would have been detrimental for a longer-term investor to get too excited over either piece of data.

Following the date of the insider "buy" signal, Goldman's stock spent the next five months plunging -- it still trades below the opening price on the day Rajaratnam was buying. As for P&G, selling a long position or opening a longer-term short based on the insider "sell" information wouldn't have worked out so well, either. Adjusted for dividends, P&G's stock is currently up 21% from that date.

Play to your strengths
Trying to play the short-term game is rife with challenges for anyone. For individual investors who don't devote themselves full-time to their investing and don't have the resources of big institutional investors, it becomes even more daunting. Throw in the very real possibility that many professional investors may be getting information that other investors don't have access to -- and you've got a seriously stacked deck.

But it's a much different story when it comes to longer time horizons. Professional investors look at stocks like Abbott Labs (NYSE: ABT  ) and Intel (Nasdaq: INTC  ) -- two stocks that I own and am a big fan of -- and start throwing around phrases like "dead money" because they don't see a scenario where these companies' strong profits, low valuations, and growing dividends will pay off now.

I don't care about that. I look at these companies' strong profits, low valuations, and growing dividends, and I see, well, strong profits, low valuations, and growing dividends. So let the Rajs of the world flip shares back and forth with investors that want to go head-to-head with him in the short game. I'm going to hang onto my shares and let these companies work for me over the next five, 10, or, heck, 30 years.

Do you think the markets are rigged? Head down to the comments section and weigh in.

Intel is a Motley Fool Inside Value recommendation. Yahoo! is a Motley Fool Global Gains pick. Intel and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended a diagonal call position on Intel. The Fool owns shares of Abbott Laboratories and Yahoo!. Alpha Newsletter Account, LLC owns shares of Abbott Laboratories. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Intel and Abbott Labs, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (3) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 13, 2011, at 7:57 PM, TMFHockeypop wrote:

    Matt, I agree with you ... sorta. I DO think that it is hard to beat the indices on a risk even basis.

    BUT,

    1) It's fun to try;

    2) You'll enjoy Howard Marx's "The Most Important Thing: Uncommon Sense for the Thoughtful Investor"

    I think you two think alike (and that's a BIG compliment.

    It's probably one of the top three business books I've read in the last year or so.

  • Report this Comment On May 13, 2011, at 8:20 PM, TMFKopp wrote:

    @hockeypop

    Interesting you mention "The Most Important Thing"... Just downloaded it on my iPhone and it's next on my reading list after "Relentless Forward Progress" (a good read for masochistic runners).

    And thanks for the compliment!

    Matt

  • Report this Comment On May 15, 2011, at 10:39 PM, techy46 wrote:

    Is the Market Stacked Against You? Maybe, depending on what you think. It's not a buy and hold game anymore. You have to consider more than stock fundamentals including financial news, investing trends and world politics. Then you have to overcome the herd physchology and avoid being greedy. Intel's a perfect example,great fundamentasl, caught in the "PC's dead" herd hype, driven down by recession but coming on strong by new technology and far east sales growth, Good investment, in and out low and hi 20s depending on overall market range.

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