Stock prices are a random walk toward greater wealth

In another section of Against the Gods by Peter Bernstein, he discusses whether or not the stock market truly moves in a "random walk" -- if it does, the graph of the market should resemble a normal distribution, or bell curve.

He graphed the moves of the markets for every month for 70 years, and found that they did indeed resemble a normal distribution bell curve -- with two differences.

First, there is an upward bias. That is, the long run the stock market does go up. We know that. And it proves that capitalism works. Our free market economic system is, on the whole, creating wealth, and this is reflected in the stock market.

Second, the "long tail" at the left is much bigger than a strict normal distribution would call for. This means, paradoxically, that extreme market moves to the downside happen more frequent than is statistically probable. His graph would have included the 1973-1974 downturn and the October 1987 crash.

Short term market results are not predictable. Stock prices change as a result of new events and information, but these events are unpredictable. Therefore, they add up to a random walk that as Burton Malkiel has described moves upward in the long run, thanks to the wind of economic growth.

If you want steady Eddy market prices you have to go with something like Treasury Inflation Protection Securities that increase in value on a regular basis and also have the benefit of going up at the inflation rate.



random walk
random walk