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The Texas economy: the stock market in the 1990s.

The Texas Economy: The Stock Market in the 1990s

For the last twenty years, the most widely circulated academic theory about the stock market has been the "efficient market theory." The theory is simple: to know what the stock market will do tomorrow, you just toss a coin. If it comes up heads, the market will rise; if tails, it will fall. The theory has a 50 percent success rate. Most big investors are not willing to pay much for that type of information. Nevertheless, the theory has powerful academic arguments and empirical evidence favoring it. Unfortunately, the efficient market theory cannot distinguish actual stock price behavior from investments by a colony of baboons whose stock purchases are driven by serially uncorrelated hormone surges. In addition, the efficient market theory has come under increasing attack by both the popular press and academics.

Consider the existing academic research dealing with anomalies, or occurrences that are inconsistent with efficient market theory. The "weekend effect" suggests that stock returns are high on Fridays but low on Mondays. The "turn of the month effect" indicates that stock returns are higher during the first few days of the month than through the rest of the month. The "preholiday effect" finds that stock returns are abnormally high on the days before national holidays. The "January effect" indicates that the stock market goes up significantly in January compared to other months. Because of their low transactions costs, institutional investors could make money from all of these effects.

The anomaly reported in this article is the "decade effect." In examining the data, I found that even decades do better than odd ones. Since 1870, every single even-numbered decade has outperformed every single odd-numbered decade with the exception of the 1950s. Both the 1920s and the 1950s were strong because they were postwar decades. The graphic presentation of the effect appears in the two figures below.

What are the implications of this effect for the 1990s? If history repeats itself, the nineties will be a decade of "malaise," which Webster's defines as "a lack of health . . . accompanying the onset of an illness." I do not believe that a great depression will occur in the 1990s. Economists have learned too much since the 1930s about monetary and fiscal policy to repeat the Great Depression.

My opinion is that the U.S. economy will be flat in the 1990s and then decline. I believe the illness following the malaise of the 1990s will result from the growth of redistributive lawyering, lobbying, and rent seeking as outlined in Black Hole Tariffs and Endogenous Policy Theory (Magee, Brock, and Young, 1989). The economic decline in the United States brought about by excessive litigation is illustrated in the accompanying figure taken from chapter 8 of that work. This economic decline could be avoided but only with a major change in current behavior.

Notice the company that the United States. keeps in the diagram: Costa Rica, India, Bangladesh, Chile, and Nepal. With regard to lawyers, the United States is not exactly associating itself with world powers. The United States is similar to Costa Rica, India, and the others in having more lawyers than doctors. In 1983, the United States had 565,000 lawyers compared to about 440,000 doctors in 1980. By 1989, the number of lawyers was up to about 750,000 according to Business Week (November 6, 1989, p. 34). A destructive aspect of this is the drain of society's most talented individuals out of the creative process and into redistribution.

Although it would not be possible or desirable to take our lawyer ratio back to zero, I have proposed elsewhere a measure to halt the growth in the number of lawyers: an amendment to the Constitution to prohibit the creation of new lawyers. Even with such a measure, it might take several decades to get our lawyer ratio down to Japanese levels. In the meantime, we appear to be facing a decade of malaise in the market.
COPYRIGHT 1990 University of Texas at Austin, Bureau of Business Research
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Author:Magee, Stephen P.
Publication:Texas Business Review
Date:Apr 1, 1990
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