Stocks soaring for senators: are members of congress enjoying the benefits of insider trading at the expense of taxpayers?

"SENATORS' STOCKS beat the market by 12%" blared a headline in the Financial Times. So what? Isn't beating the market what everyone tries to do? That is the main reason most people read the Financial Times in the first place. We hire stockbrokers, listen to the experts on CNNfn, watch "Wall Street Week" on PBS, and buy books that teach us how to pick stocks because we all are trying to beat the market. When choosing a mutual fund, we are looking for portfolio managers that will do better than the average. Shouldn't senators be able to hire the very best financial advisors available?

Logically speaking, the argument that experts should be able to predict which stocks will be winners or losers is profoundly seductive. It is deceptively obvious that money managers, who study the ups and downs of the market, examine the balance sheets of companies in minute detail, follow the latest innovations in products and technology, and use all the other sophisticated tools and techniques at their disposal, should be in the best position possible to forecast future stock prices. Alas, like so many other no-brainers, this one is blatantly false.

For decades, academics have known that it virtually is impossible to beat the market. This is referred to as the efficient market hypothesis, which contends that, if a person is using publicly available information only, that individual is highly unlikely to beat the market by a significant amount. Public information is anything you, your broker, or your portfolio manager normally have access to, including corporate financial statements, publications such as The Wall Street Journal and Baron's, whatever you see on TV, everything available on the Internet, all the books in the library, and whatever else is in the public domain. You might be especially lucky (or unlucky) for brief periods of time in much the same way as you might get lucky for one night at a blackjack table. Over the long haul, though, you likely will be very close to the market average.

The key to comprehending the efficient market hypothesis is understanding the difference between a great company and a great stock. Suppose your broker calls you about a great company. The firm has a strong balance sheet, brilliant management team, and a fabulous product, which is poised to take off in the next 12 months. He wants you to buy the stock. Let us suppose the broker is right on target. This undoubtedly is an outstanding company, but is it an outstanding investment opportunity? It is highly unlikely. You believe you have been given a hot stock tip. In fact, you have received very old news, relatively speaking.

As with virtually all publicly traded companies, the value of this firm's stock constantly is being analyzed and reanalyzed with high-speed computers using all available public information by hundreds of portfolio managers and analysts who are making recommendations to thousands of clients. In many cases, these "tips" are acted upon immediately, sometimes via computer trading. By the time you have heard about this company, the institutional investors and thousands of people already have bought millions of shines because they have come to the same conclusion--this is a great company. The price of the stock has been pushed up so high that it no longer is a bargain and, in some cases, perhaps no longer even reasonable. At this point, the company must earn an exceptional profit if investors are to receive merely an average return. Anything less probably would disappoint investors, causing a sell-off and the share price to tumble. This adjustment to new information does not take weeks or days, rather minutes, even seconds. In a sense, if you received the advice from your broke/, the expert, you might as well be the last person on Earth to know about this great company.

The stock market reacts to publicly released news almost instantaneously. This is market efficiency, thus the name, the efficient market hypothesis. It has been tested hundreds of times by hundreds of scientists. To date, every credible study comes to the same conclusion: The common stock market is extremely efficient, despite suggestions to the contrary made by financial service companies.

If the technical aspects are not convincing enough, think about this: If you consistently could pick the winning horses at the racetrack, wouldn't it lower the odds and reduce the pay-out if you told other people which horses to bet on? If you had a system for beating the house in Las Vegas, wouldn't you kill the goose that laid the golden egg if you wrote a book showing others how to do it? If you had a foolproof scheme of picking winning stocks, why would you share that information with me for a lousy six percent commission? Rest assured that, if I could pick stocks with that kind of accuracy, I would be on a beach in Tahiti armed only with my laptop computer and a phone, calling in orders to my broker.

Now, you might ask, "What about investors like Warren Buffet or Peter Lynch? How do you explain them?" Frankly, we don't. Maybe they know something: maybe they don't. Granted, many of the stocks they have chosen have done quite well over the years, but them are very few that have done nearly that well. Statistically speaking, them always are outliers in any random distribution. Although most will hover around the average, a few will stray well below--or above--average. This is not necessarily skill, but rather chance.