The Mirage of the Financial Singularity
Many economists and financial-market observers seem to believe that we are approaching the point when even Warren Buffett would be better off leaving all investment decisions to a computer program. How, then, would they explain the recent plunge in China's stock market?
NEW HAVEN – In their new book The Incredible Shrinking Alpha, Larry E. Swedroe and Andrew L. Berkin describe an investment environment populated by increasingly sophisticated analysts who rely on big data, powerful computers, and scholarly research. With all this competition, “the hurdles to achieving alpha [returns above a risk-adjusted benchmark – and thus a measure of success in picking individual investments] are getting higher and higher.”
That conclusion raises a key question: Will alpha eventually go to zero for every imaginable investment strategy? More fundamentally, is the day approaching when, thanks to so many smart people and smarter computers, financial markets really do become perfect, and we can just sit back, relax, and assume that all assets are priced correctly?
This imagined state of affairs might be called the financial singularity, analogous to the hypothetical future technological singularity, when computers replace human intelligence. The financial singularity implies that all investment decisions would be better left to a computer program, because the experts with their algorithms have figured out what drives market outcomes and reduced it to a seamless system.