American Investment Services, Inc.

Disciplined, Diversified, & Cost Effective

Mar. 2004 – Martha, et al.

The highly publicized case against Martha Stewart has focused attention on the notion of insider trading. These events, as well as the trend described by the Wall Street journal article reprinted herein, serve as a reminder that individual investors are not well served by stock picking.

The capital markets assimilate information with stunning efficiency. This phenomenon is lethal to gamblers and market prognosticators who bet against it, but enormously generous to true investors, who recognize the market’s brutal efficiency as an engine of economic growth, and patiently accept the returns of well-diversified asset classes.

There is a mystery, however, in the functioning of markets. If, after all we were all to accept the wisdom of passive investing and accept prices as given, who would be left to set those prices? It is our view that there are in fact buyers and sellers who, at the margin, have an edge. There are no doubt individuals who, in the parlance of the economist, have a lower marginal cost of gathering and interpreting information concerning specific companies. But don’t look for them in your local stock broker’s office. They typically work exclusively in obscure fields, devoting all of their efforts to pursuing minute bits of information that might provide an advantage. Several are described in the Wall Street journal article. But superior knowledge does not necessarily result in great profits, for even these experts live in a competitive world, and we doubt that the prices they receive for their services greatly exceed their costs. In any event the article makes it clear that immediate access to this type of information is all but impossible for individual investors.

If well functioning markets depend on individuals with a relative advantage in information gathering, the notion of “insider trading” becomes a very grey area. Who is, after all, an insider? If it is any buyer or seller directing capital among assets based on their presumably superior knowledge, then attempts to prohibit the practice arguably interfere with the efficient flow of capital. Most efforts are impractical in any event. Insider trading, for example (buying and selling), is closely scrutinized, but what about insider holding? Is it inconceivable that an investor privy to unreleased “good news” has held his shares during a market rout?

The bottom line is you should not lose sleep worrying about insider trading, for there is a readily available antidote known as portfolio diversification. Our recommendations provide exposure to the desirable risk of our recommended asset classes, which have historically been rewarded with commensurate returns, and dispense with these firm-specific and industry-specific risks that are not systematically rewarded.

Also in This Issue:

Increasingly, Stock Research Serves The Pros, Not ‘Little Guy’
Mutual Fund Rankings: Approach with Caution
The Gold Standard
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles