Yesterday Mark Thoma had an interesting look at the efficient market hypothesis (EMH) and cited a couple of papers in an exploration that questions the value of the theory.
One way to think of EMH is that the market prices in all known information. So then the task of beating the market, for those interested in beating the market, becomes trying to figure out what the market does not know.
Based on what we have seen over the last decade or so it seems like maybe the markets know very little. My thoughts have been the same for a while. I do believe that markets price most things correctly most of the time and does provide various types of warnings but things change and the market does get some things wrong, more correctly perhaps it fails to anticipate things.
Markets go through cycles and changes in cycles are often marked by similar things. Additionally the fortunes of companies change. Some company we are not familiar with (maybe it doesn't even exist yet) will come up with a drug that will cure some previously incurable malady and make a lot of money doing so. Along its way it will have various tests and milestones to work through and maybe competitors to beat to the market but it will happen and some folks will successfully navigate all of that in owning the stock.
Another way to view EMH is that it believes markets are rational. Well do you believe in that enough to let your financial future ride on it? The market is made up of its participants which are people and people are from from rational. If markets rationality could be relied upon then I don't think Pets.com and Webvan would have ever IPO'd, the Nasdaq would not have gone above 3000 ten years ago and Johnson Control would not have dropped 75% a year ago.
Additionally, at some point some well regarded mega cap company will do something, like make a huge and peculiarly timed acquisition ala BAC buying MER, that will impair its future prospects for some lengthy period of time and some folks will see that for what it is and get out in a timely fashion.
The notion that no one can pick good stocks or avoid bad ones implies that no one can do analysis which seems like an odd conclusion to draw. This is not to say analysis is easy or that anyone who does analyze companies will always be correct but fundamental attributes change and these changes often influence prices and some of these changes can be observed and navigating them is not impossible.
Looking at the country level from the top down it is simple work to get the statistics for a place in terms of debt levels and GDP and get a sense for what makes the country tick. It is also easy however to view a country as being healthy but draw the wrong conclusion about stock prices in the short term but as we look at the world now countries with low debt and good growth prospects are a likely to treat your money well over the long term regardless of what the market "knows."
A final point here is that a theory that relies on the type assumptions that EMH relies on is a tricky business. Assumptions about efficiency and rational behavior strikes me as a huge leap of faith and while there are people who are clearly comfortable relying on this with their money it is not what I will bet my financial future on.
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18 comments:
Roger,
if you be so kind, to give a reference what are the factors to look for in a country analysis and selections and that are the turning points. For instance Brasil was a basket case, then there was a turn around. How one know what to look for in a turn around in a country?
tx,
Jeff from Mian, Italy
Dumb is a little harsh...perhaps mentally challenged! I take the perspective that the markets have selective blindness and move in with the swiftness of a Ninja assassin when they trip over an idea.
"...but as we look at the world now countries with low debt and good growth prospects are a likely to treat your money well over the long term regardless of what the market "knows." "
I do not disagree with you, but then get your money out of the USA.
Jeff it has been many years now since I first bought VALE. One bit of continuous thread to this is picking countries with different fundamental characteristics than my home market, the US. Commodity based becomes the easiest to pick in that regard.
From what I remember it was obvious to me that certain emerging markets were going to see life on the ground improve (modernize) dramatically and the Brazil was clearly going to participate in that because of the vast resources.
OT
People have asked what I look at and since I look at lots of things I have not answered but here is a list in no particular order
differences in various interest rates
Federal Reserve actions
money supply measures
Cash levels
Inflation
GDP growth
Dividends yields
P/E
Long term market activity charts and trends
new highs and lows
advancing issues versus declining issues
Sentiment indicators
SEG
SEG,
What are your views regarding Benjamin Graham's writings? P/Es, dividend yields, and comparative interest rates figure heavily in his views. Many say his writings are antiquated, but I think that the more things change, the more they remain the same.
Graham was a genius and warren Buffet has proved that.
O/T re: yesterday--There's an AP article up at Yahoo Finance which notes that foreign demand for US Treasuries fell by a record amount in December. Japan is now the largest foreign holder of our debt, with China falling to #2.
Maybe only the equity market is dumb.
You think the bond market realizes the USA will not be able to borrow its way to wealth and prosperity?
Keynesian policies are complete madness and total stupidity.
Even our socialist friends across the pond try to limit debt levels to 3% of GDP
Just returned from travel and no time for much comment (hold applause please [lol]) but I second Mark Thoma's blog as a resource: He's a heterdox economist who consistently writes clearly at a high level, honestly examines alternative viewpoints and polices links well including the critique of EMH's weak form that Roger refers to.
WRT country analysis, even if the information may be suspect for one reason or another, central banks are an important source of fundamental country data for any investor and their commentary offers insight into elites' thinking. For example the latest commentary from the SF Fed at http://tinyurl.com/yju5lst wouldn't make a value investor very happy, might slightly trouble a liquidity investor's longer-term view but wouldn't disturb a momentum investor's assessment of short to intermediate trend much at all.
Which brings up the final point that the investor's conceptual framework does matter, a lot: Develop some clarity there and it will do wonders elsewhere as long as it doesn't become too rigid (EMH was a great framework for model building but its equilibrium stance and inability to account for exogenous shock rendered it helpless in the face of a black swan-style event).
"We anticipate a turnaround this year, but, instead, we could be facing a jobless recovery with long durations of unemployment..."
RW,
How come when these predictions were made here last year you said we could not have a jobless recovery. Have you changed your mind and now embrace the concept?
I never pay attention to what people claim I said because it is rarely accurate and not infrequently rephrased as a straw man to help the claimant feel more secure.
Show me the link and I'll respond to what I actually said but as a prelude (since I tend to be logically consistent) it was probably something on the order of pointing out that a concept such as "jobless recovery" was deeply flawed (I may have said idiotic) as an economic model -- business cycle theory and cyclic recoveries are fundamentally grounded in closing the output gap and increasing employment rates -- and was also frankly objectionable as a public policy model.
The conclusion being there was no foundation to the market other than liquidity and any long-term value investing strategy would absolutely mandate continued hedges. Tactical approaches, which I do use because I generally follow the permanent v. variable portfolio model, should be favored to add alpha instead.
Shorter version: The term "jobless recovery" fits on a bumper sticker and is widely reported but it is a description, not a variable, so it is irrelevant to my models which fully account for the long-term impact of degrading jobs market (hint: it's really, really bad).
I think the appropriate word to describe markets is "retarded".
Shows my age and lack of current social sensitivity.
bull markets follow bear markets.
Death follows life but betting on when and how can become complicated, at least that's what the insurance guy said when he was trying to sell me term life. [lol]
"In the night all cats are gray" is a truism about human vision that could also apply to areas other than the retina but in the end everyone must interpret what they see on their own; I rather like Tom Drake's take at http://tinyurl.com/ylrerxb on that.
RW,
your posts were much better in the old days when you weren't such a smarty pants.
Smartypants? Since I can't tell which Anonymous you are I'll assume you've been around long enough to say that but you're probably right; I do seem to be getting more cranky in my old age.
I'll try to behave myself.
(but you'll have to forgive me if I occasionally insist that analysis rise above the level of political talking point or bumper sticker).
Take care and good evening.
RW,
Having thought about what I said, and seeing that you are such a gentleman about it, I am sorry for the insult. This is not my blog and I was out of line for making that harsh comment. I was not trolling or trying to start anything. Again, my sincere apology.
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