By Ann Coleman (TMF AnnC)
April 6, 2000

Everyone who isn't stranded on a raft in the middle of the Atlantic subsisting on raw fish and rainwater has probably noticed that the markets have been rather exciting this week. Actually, I said that last week, which was exciting enough but pales in comparison with Tuesday's gyrations, which saw both the Nasdaq and the Dow oscillating 500 points in a day.

Maybe things are settling down a bit now, or maybe the markets will continue to entertain us with their little tricks. Either way, I hope you have Foolishly refused to be panicked into any kind of action. While today saw many tech stocks gaining back some of their losses, there's no guarantee that the show is over, yet -- and none of this nonsense means anything to us.

Right?

Good. There's never been a better time to practice our mantra: think long-term, think long-term.

Through all this, the Foolish Four has done very well. We are up over 5.5% for the month (all four days of it!) and are back into position ahead of the Dow and the S&P 500. What a relief! It is a relief, right? You were starting to doubt, right? Yeah, me too, a little. The Foolish Four message board certainly had a bad case of that for a while. The validity of the strategy came under increasing attack when the portfolio was behind the market.

Of course, the fact that we are beating the market this month really doesn't prove the validity of the strategy any more than being under the market for a while invalidated it. In fact, nothing at all will ever prove that the strategy will work going forward. However, we will shortly have at our disposal a database that should answer most questions about the validity of the RP formula as a stock selection criterion. We will be buying a commercial database of price and dividend information on the 500 largest U.S. companies by market cap from 1950-1999.

It will take some time to digest that massive amount of data, but when we do, we will share that information with you right here. Whatever we find.

Critics of the Foolish Four tend to be those who believe in the Efficient Market Theory (EMT), which holds that markets are so efficient at pricing stocks that it is virtually impossible to beat the market in the long run, and anyone who does is essentially just lucky. I tend to think that if that were true, all those legendary investors we read about, guys like Warren Buffet, Peter Lynch, or George Soros, would be average guys with high school educations. Anyone want to make the case that any of them have IQs under 150?

I think that "Chance favors the well prepared" is a better way to describe their "luck."

I wrote on Tuesday that the prevailing mood at the Mechanical Investing Convention last weekend was faith in mechanical investing and faith in the Mechanical Investing community. My use of the word faith has bugged me ever since. So I Iooked the word up in the dictionary, and lo and behold, the first definition was loyalty.

faith [1] (noun), plural faiths

[Middle English feith, from Old French feid,
 foi, from Latin fides; akin to Latin fidere to trust]

First appeared 13th Century
 1 a : allegiance to duty or a person : LOYALTY
   b (1) : fidelity to one's promises
     (2) : sincerity of intentions
 
 2 a (1) : belief and trust in and loyalty to God
     (2) : belief in the traditional doctrines of a religion
   b (1) : firm belief in something for which there is no proof
     (2) : complete trust
 
 3 : something that is believed esp. with strong conviction;
  especially: a system of religious beliefs

 synonym see BELIEF

The "firm belief in something for which there is no proof" part I'm not too crazy about, especially when it comes to my money, but the "sincerity of intentions," "fidelity to one's promises," and "strong conviction" parts aren't so bad. In fact, it describes the MI Convention folks pretty well. But is it reasonable to have faith in a stock strategy? Not the "complete trust" kind. After all, the world is full of Wade Cooks looking to exploit financial faith.

Proof comes in various sizes. What we analytical types are basing our "faith" on is statistical proof that any statistician will tell you can never really prove anything. So we base our faith on the probability that something is right, not absolute knowledge. This makes some people very uncomfortable. For me, saying that I have faith in mechanical investing is a shorthand way to say that I have seen enough statistical analysis to make me comfortable with the belief that it is highly unlikely that the success of these strategies is due to chance, and from that I have concluded that investing in them is a rational thing to do. That's faith, but not blind faith.

EMT advocates, however, seem to cling to a belief in that theory in the face of much evidence to the contrary. The logic appears to be that since markets are efficient, no one can beat them, and, therefore, anything that does beat the market is merely a random statistical variation that cannot continue into the future. Am I missing something or is that a glaringly circular argument?

I don't think anyone argues that markets are not generally efficient, but there are plenty of temporary and even long-term pricing inefficiencies that leave room for individual investors to exceed market returns over the long run. I intend to be one of those investors and the Foolish Four is part of my plan to do so. (But I am still very curious to see what that big database has to say.)

Oh, yes, if you were on a raft in the Atlantic ocean living on rainwater and raw fish this week (or if you thought that sounded interesting), you might enjoy this book: Adrift.

Keep the faith!

Fool on and prosper!